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Illustrate and discuss why the relationship between the optimal Pigovian tax and the marginal external cost...

Illustrate and discuss why the relationship between the optimal Pigovian tax and the marginal external cost at the socially efficient output level is affected by market structure.

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Answer: A firm that produces a negative externality would be paying the marginal private cost and a Pigouvian tax equal to the externality, and consequently decreases its production to the socially optimal level of output, because it would also be paying for the damage caused to others. On contrary a firm that produces a positive externality then the market would be producing less than the socially optimal quantity of the product or service, because there is an advantage to society that is not captured by the individual.

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