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Suppose the production of widgets causes a negative externality of $12 per unit. The current market...

Suppose the production of widgets causes a negative externality of $12 per unit. The current market price is $20 and market quantity is 35 units.

What should be the correct Pigovian tax to correct the negative externality?

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Answer #1

So the current market quantity = 35 units and market price = $20. Such an outcome is determined by the intersection of the Demand - MB curve and MPC i.e. Marginal private cost curve. After the negative externality of $12, the socially optimum market outcome is determined by the Intersection of the Demand - MB curve and MSC i.e. Marginal social cost curve. MSC = MPC + Negative externality.

Therefore, the correct Pigovian tax to correct the Negative externality is equal to $12.

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