Suppose that our local power station burns coal to generate electricity. The demand and supply functions for electricity are given by P = 8 - (1/4)Q and P = 2 + (1/2)Q, respectively. However, for each unit of electricity generated, there is an externality. When we factor this into the supply side of the market, the real social cost is increased, and the supply curve is P = 3 + Q.

a)Graph the demand, the free market supply and the supply with the externality.

b)What is the free market equilibrium level of production?

c) What is the efficient (i.e, socially optimal) level of production?