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Assume a market exhibits externalities of $40 per unit and supply 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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Answer #2

When externality per unit is $40, pigouvian 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.

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