Chapter 16, Problem 2P

To determine

To Explain:

Pigouvian tax.

Concept Introduction:

Externality in Economics:

In economics, externality is a concept which discusses the consequence of an economic activity which can have a positive or a negative impact on the third party who is completely unrelated to the activity.

Positive externality:

Externality which creates benefit to the third party is positive externality.

Negative externality:

Externality which creates harm to the third party is negative externality.

Marginal Social benefit:

The marginal social benefit is the change in total benefit to the society from the consumption of one extra unit of a good or service.

Marginal Social cost:

The marginal social cost is the change in total cost incurred by the society for the consumption of one extra unit of a good or service.

Marginal individual benefit:

The marginal individual benefit is the change in total benefit to an individual from the consumption of one extra unit of a good or service.

Marginal individual cost:

The marginal individual cost is the change in total cost incurred by an individual for the consumption of one extra unit of a good or service.

Socially optimal level of output:

The level of output at which marginal social benefit is exactly equal to marginal social cost is known as socially optimal level of output. If output is at some other point, market failure exists. It is also known as the allocative efficient level of output

Pigouvian tax:

Tax that is imposed in the market with negative externality. It is imposed to correct the inefficiency created by the negative externality.

Pigouvian subsidy:

Subsidy that is provided in the market with positive externality. It is provided to correct the inefficiency created by the positive externality.