Suppose the factory Afro-Puffs Inc. produces wigs. As a by-product of this wig production, they also produce dangerous emissions of toxic gases (as a result of the strong glue used to hold the hair in place). The De-Lite car factory, down the road, experiences a negative externality from this production process. Suppose that the supply curve (private marginal costs) for the wig factory is Qs = (2/5)P – 2, and it faces a market demand of Qd = 15 – P/2. The marginal damages caused by the production of wigs can be written as P = Q + 1/2.
a. Find the equilibrium price and quantity in the market for wigs .
b. Find the socially optimal level of wigs and the corresponding price.