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  • Graphical Representation of a Pigouvian Tax for Consumption Externalities

Evaluating a Corrective Tax Policy

A government is considering a per-unit tax on consumers of a product that has negative effects on society. Proponents argue this tax will correct a market failure and improve overall social welfare. Using a graphical model that distinguishes between private and social benefits, evaluate this argument. Your response should explain how the tax alters the market equilibrium and why the new outcome is considered more efficient.

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Economics

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Introduction to Microeconomics Course

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Evaluation in Bloom's Taxonomy

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  • The following graph illustrates the market for a product that generates a negative externality from its consumption. The curves represent Marginal Social Cost (MSC), Marginal Private Benefit (MPB), and Marginal Social Benefit (MSB). The market is initially at equilibrium at quantity Qm. The socially optimal equilibrium is at quantity Qopt. To correct this externality, the government imposes a per-unit tax on consumers. Based on the graph, what is the size of the tax required to reach the socially optimal quantity, and what is the total price consumers will pay per unit (including the tax)?

    A standard supply and demand graph for a negative consumption externality. The vertical axis is Price (P) and the horizontal axis is Quantity (Q). There is an upward-sloping curve labeled MSC (Marginal Social Cost). There are two downward-sloping curves. The higher one is labeled MPB (Marginal Private Benefit) and the lower one is labeled MSB (Marginal Social Benefit). The intersection of MSC and MPB defines the market equilibrium at quantity Qm and price P2. The intersection of MSC and MSB defines the socially optimal equilibrium at quantity Qopt and price P1. A vertical line is drawn up from Qopt, intersecting the MSB curve at price P1 and the MPB curve at price P3.

  • Evaluating a Corrective Tax Policy

  • The following graph illustrates a market where a per-unit tax has been imposed on consumers to correct for a negative externality, moving the market to the socially optimal quantity (Qopt). Match each economic concept with its corresponding representation on the graph.

    A standard supply and demand graph for a negative consumption externality with a tax. The vertical axis is Price (P) and the horizontal axis is Quantity (Q). There is an upward-sloping curve labeled MSC (Marginal Social Cost). There are two downward-sloping curves. The higher one is labeled MPB (Marginal Private Benefit) and the lower one is labeled MSB (Marginal Social Benefit). The intersection of MSC and MSB defines the socially optimal equilibrium at quantity Qopt and price P1. A vertical line is drawn up from Qopt, intersecting the MSB curve at price P1 and the MPB curve at price P3.

  • In a market with a negative consumption externality, a corrective per-unit tax is imposed on consumers, moving the equilibrium to the socially optimal quantity. At this optimal quantity, the vertical gap between the marginal private benefit curve and the marginal social cost curve represents the full amount of the ______.

  • A government imposes a corrective tax on consumers of a product that generates a negative externality. Arrange the following graphical and economic effects in the logical sequence they occur.

  • In a market for a product, each unit consumed creates a negative external cost of $5 for society. To address this, the government imposes a $3 per-unit tax on the consumers of this product. What is the most likely outcome of this policy?