Taxing and subsidizing output. The inverse demand for coal-fired electricity is:

P(Q) = 6 2Q

where Q is megawatt hours of electricity. The marginal costs of producing electricity (aka supply) are:

MC(Q) = Q

In addition to providing benefits to consumers, electricity generation also leads

to harmful emissions of sulfur and mercury. These emissions cause health

problems which lead to reduced productivity, and degrade the environment.

Economists have estimated that the marginal damages from electricity generation are:

MD(Q) = 0.5Q

a) Compute the market outcome. Would an unregulated market ever produce

less than 2 megawatt hours? Why or why not?

b) Compute the efficient quantity of electricity generation. What are marginal

damages at the efficient quantity?

c) Suppose the Department of Energy decides to subsidize coal electricity generation (this policy is under serious consideration.) How would this affect the marginal cost of producing coal? Will this lead an efficient outcome?Why or why not? What should be done to achieve an efficient quantity of electricity?