(8th edition) (the pearson series in economics) robert pindyck, daniel rubinfeld microecon 273

248 PART • Producers, Consumers, and Competitive Markets Capital D (machinehours per month) 5000 F 4000 3500 B 3000 A 2000 1000 Output of 2000 Tons of Steel per Month E 5000 10,000 12,000 C 18,000 20,000 Wastewater (gallons per month) F IGURE 7.5 THE COST-MINIMIZING RESPONSE TO AN EFFLUENT FEE When the firm is not charged for dumping its wastewater in a river, it chooses to produce a given output using 10,000 gallons of wastewater and 2000 machine-hours of capital at A However, an effluent fee raises the cost of wastewater, shifts the isocost curve from FC to DE, and causes the firm to produce at B—a process that results in much less effluent removal methods or private treatment plants are relatively expensive Because taconite particles are a nondegradable waste that can harm vegetation and fish, the Environmental Protection Agency (EPA) has imposed an effluent fee—a per-unit fee that the steel firm must pay for the effluent that goes into the river How should the manager of a steel plant deal with the imposition of this fee to minimize production costs? Suppose that without regulation the plant is producing 2000 tons of steel per month, using 2000 machine-hours of capital and 10,000 gallons of water (which contains taconite particles when returned to the river) The manager estimates that a machine-hour costs $40 and that dumping each gallon of wastewater in the river costs $10 The total cost of production is therefore $180,000: $80,000 for capital and $100,000 for wastewater How should the manager respond to an EPA-imposed effluent fee of $10 per gallon of wastewater dumped? The manager knows that there is some flexibility in the production process If the firm puts into place more expensive effluent treatment equipment, it can achieve the same output with less wastewater Figure 7.5 shows the cost-minimizing response The vertical axis measures the firm’s input of capital in machine-hours per month—the horizontal axis measures the quantity of wastewater in gallons per month First, consider the level at which the firm produces when there is no effluent fee Point A represents the input of capital and the level of wastewater that allows the firm to produce its quota of steel at minimum cost Because the firm is minimizing cost, A lies on the isocost line FC, which is tangent to the isoquant The slope of the isocost line is equal to -$10/$40 = -0.25 because a unit of capital costs four times more than a unit of wastewater