Consider the market for electricity. Suppose demand (in megawatt hours) is given by Q=50-P and the marginal private cost of generating electricity is $10 per megawatt hour (P is in the same units). Suppose, as well, that smoke is generated in the production of electricity in direct proportion to the amount of electricity generated. The health damage from the smoke is $15 per megawatt hour produced.

i. What is the health damage cost function?

ii. Suppose the electricity is produced by competitive producers who ignore the externality. What price will be charged and what quantity of electricity will be produced. What amount of health damages will occur?

iii. Now, suppose the electricity is produced by an unregulated monopolist. How would your answer to ii) change?

iv. In ii) and iii) calculate the consumer surplus from the electricity generation. Then, calculate the net surplus, taking into account the pollution damage.

v. How would your answers to ii) and iii) and iv) change if the electricity producers are required to internalize the externality?

vi. Illustrate what do your results tell you about the relative desirability of perfect competition versus monopoly in the presence of externalities?