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6. Markets fail when allocative efficiency is not achieved; when a factory emits toxic smoke, a...

6. Markets fail when allocative efficiency is not achieved; when a factory emits toxic smoke, a negative externality is created. Why do economists justify a tax to penalize the factory in this case?

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Answer : In case of negative externality the output level is higher than the socially optimal output level. In this situation if the government impose tax on production then the production cost will increase for the factory. As a result, the factory will decrease the production. Due to this reason the output level will decrease and start reaching toward the optimal output level. Hence "economists justify a tax to penalize the factory in case of negative externality".

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