Question

What is the relationship between Pigovian taxes and market failure? How do Pigovian taxes internalize externalities? Suppose that we are able to identify that the external cost of driving cars is $5,000. How can we use a Pigovian tax to internalize this external cost? Use a graph to illustrate.

Use the personal opinion to answer，thanks.

Answer 1

Ans:-

An alternative approach is to use the price system to ‘internalize’ the externality

If we charged firms for polluting, the social cost would be incorporated in the private cost. Done correctly, firms will make optimal choices.
• This type of tax is known as a Pigouvian tax after the economist Pigou who suggested it.

This solution achieves the desired result with probably less complexity. Facing this tax, plants will choose the efficient amount of production. We do not have to write a separate law for each plant

If the marginal damage varied with the amount of pollution (plausible), then setting the right tax schedule would be much harder. For example, if pollution above a certain threshold caused mass extinction but below this, did little harm, then this Pigouvian taxation scheme would be quite risky. Setting the tax slightly too low would cause calamity.

The Pigouvian taxation has the advantage that plants will optimal choose the level of pollution that maximizes their profits, including the cost of the Pigouvian tax. But Pigouvian taxes are risky when the marginal social cost of pollution varies with the quantity — for example, above a certain threshold everyone dies. In these cases, it would be difficult and possibly risky to try to set the tax exactly right.