Incidence of Regulation Costs
The Smokey Mountain Coal Company sells coal to electric utilities in the southeast. Unfortunately, Smokey's coal has a high particulate content, and, therefore, the company is adversely affected by state and local regulations governing smoke and dust emissions at its customers' electricity-generating plants. Smokey's total and marginal cost relations are
TC = $1,000,000 + $5Q + $0.0001Q2:
MC = DTC/DQ = $5 + $0.0002Q
where Q is tons of coal produced per month and TC includes a risk-adjusted normal rate of return on investment.
A. Calculate Smokey's profit at the profit-maximizing activity level if prices in the industry are stable at $25 per ton and therefore P = MR = $25.
B. Calculate Smokey's optimal price, output, and profit levels if a new state regulation results in a $5-per-ton cost increase that can be fully passed on to customers.
C. Determine the effect on output and profit if Smokey must fully absorb the $5-per-ton cost increase.