Economics • Economic BasicsHard
Examine the theoretical implications of the 'Pigouvian Tax' in addressing market failures. How does it correct negative externalities?
A. By imposing a regulatory price ceiling on monopolistic utility providers to protect consumers
B. By levying a tax equal to the external marginal damage generated by an economic activity to internalize social costs✓ Correct Answer
C. By offering direct production subsidies to polluting firms to encourage green technology adoption
D. By establishing tradable property rights without government intervention in resource allocation
💡 Solution & Explanation
A Pigouvian tax internalizes negative externalities such as pollution by setting a tax per unit of output equal to the external marginal cost at the socially efficient output level. Subsidies address positive externalities, whereas price ceilings create deadweight losses rather than curing externalities. Arthur Pigou formulated this welfare economics concept to align private market incentives with social costs. Environmental economics relies heavily on carbon taxation models derived from this framework.
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