Answered: Suppose that a particular market…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Suppose that a particular market contains a negative externality in consumption, with MSC=MPC. What should a Pigouvian tax be set to, in order to correct the externality?

Expert Solution

Step 1

Externalities in the market occur when the action of one person makes the other one worse or better off, without suffering the cost or getting the benefit by his action.

MPC which is the marginal private cost is the additional cost to the producer for producing an additional unit of the commodity.

MSC which is the marginal social cost, involves the MPC & the damage cost caused.

Without any externality,

MSC = MPC

But when there exists the negative externality,

Marginal social cost (MSC) = Marginal private cost (MPC) + External cost( EC) where EC is the damage caused.

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