Assume a market exhibits externalities of $40 per unit andsupply and demand curves are equally...

Assume a market exhibits externalities of $40 per unit and supply and demand curves are equally steep. What is the resulting rate for a Pigou Tax?

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Expert Solution

The resulting rate for pigou is $40 per unit.

When externality per unit is $40, pigou tax will be equal to $40 per unit. In diagram vertical distance between Supply curves is $40. So distance A-B is tax per unit.

From this $40 tax, $20 will be borne by buyer and $20 will be borne by producer because both curves are equally steep. Before tax price was P0 and after tax buyer will pay P1 and producer will receive P2.

Rahul Sunny answered 2 years ago

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