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Pigouvian Tax: Correcting Negative Externalities

Optimal Pigouvian Tax Formula

To achieve a Pareto-efficient outcome in a market with a negative externality, the optimal Pigouvian tax rate, denoted as $x^*$ , should be set precisely equal to the marginal external cost ( $C'_{e}$ ) evaluated at the Pareto-efficient level of output ( $Q^*$ ). The formula is expressed as $x^* = C'_{e}(Q^*)$ . Imposing this specific tax rate incentivizes producers to voluntarily adjust their production to the socially optimal quantity, $Q^*$ .

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CORE Econ - The Economy 2.0: Microeconomics

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Introduction to Microeconomics Course

The Economy 2.0 Microeconomics @ CORE Econ

Ch.10 Market successes and failures: The societal effects of private decisions - The Economy 2.0 Microeconomics @ CORE Econ

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Learn After

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