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1. (60 points) The daily market for electricity is characterized by the demand curve Q = 36 – 6P and the supply curve Q = 3P, where Q = kWh per day and P = price/kWh. The production of electricity generates pollution and creates an externality. Economists estimate the marginal externality cost to be $3 per kWh. a) Construct a graph that includes the demand curve, the supply curve, and the social marginal cost (MSC) curve. b) Solve for the free market equilibrium quantity and label this on your graph. c) Calculate the consumer surplus, producer surplus, and total externality costs in the free market. Label these on your graph. Calculate the total surplus. d) Solve for the efficient quantity, taking into account all societal costs and benefits. Suppose a Pigovian tax is proposed to correct the market failure. e) How large should the tax be to achieve the efficient outcome?
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