2. Consider the steel industry from Homework 1. For your convenience, the information is replicated below, as well as the construction costs of the three types of furnaces and the cost

of capital (which is new information). The steel industry produces steel in an energy intensive process by reducing iron ore, or by melting recycled scrap. The market for steel in the EU is perfectly competitive, and for simplicity we assume that there is no trade with countries outside the EU. The industry consists of many price taking firms that produce steel using one of three types of processes: Basic Oxygen Steelmaking (BOS), Energy Optimization Furnace (EOF), and reprocessing scrap metal using Electric Arc Furnaces (SEAF). Each steel mill employs only one process, and all mills using a particular type of process are (assumed to be, for simplicity) identical. Their characteristics are described below: Steel making process BOS EOF SEAF Average variable cost (Euros per kilo) 9 5 14 Total daily fixed cost (thousands of euros per day) 6 30 8 Daily capacity of factory (thousands of kilos per day) 2 3 2 Number of factories 60 30 15/nFor any steel making process, average variable costs are constant for any volume of output up to full capacity operation. Fixed costs are not recoverable in the short run. Once built, a mill lasts forever, unless it is permanently closed down. The cost of capital in this industry is approximately 10% per year. In addition, you learn that BOS furnaces cost approximately 80.3 million euros to construct. EOF mills cost 295.65 million euros, and SEAF mills cost 124.1 million euros. EOF mills have uses other than steel production, and could earn profit of 98.55 million euros in NPV if (permanently) converted to a different industrial process. a. Suppose the demand for steel in the EU is estimated to be Q=490 - 10P, where P is the price per kilo in euros and Q is thousands of kilos per day. What do you predict will be the price of steel in the short run? b. For each of the three technologies, would you recommend that a currently existing mill continue to operate, or exit the industry? Would you recommend construction of a new mill, and if so, which technology would you recommend? What price do you predict for EU steel in the long run? c. The EU is considering subsidizing producers using the SEAF technology by €2 per kilo, to encourage recycling and environmentally friendly technologies. What impact will this subsidy have on the price of steel in the EU? d. How large a subsidy would the EU need to offer in order to encourage the adoption of the SEAF technology? e. Suppose a technological innovation reduces the operating cost of BOS furnaces (both currently existing and newly constructed) from 9 euros per kilo down to 3 euros per kilo. What would you expect to happen to the price of steel in the EU in the long run? f. Now what advice would you give to the manager of a currently operating SEAF furnace? An EOF furnace? After the innovation, how many furnaces of each type would you expect to see operating in the long run?