A Pigovian tax internalizes an external cost because
A) the cost then enters the decision-making process of the producer.
B) it would be collected by the Internal Revenue Service.
C) the revenue is used to compensate injured parties.
D) no transactions costs are created.

Question

Quizplus · Accepted Answer

A Pigovian tax imposes a tax equal to the external cost of a negative externality, such as pollution. By doing so, the cost becomes part of the producer's cost function, making them consider the negative impact of their actions on society when making production decisions. This internalization of the cost leads to a more efficient allocation of resources and reduces the negative impact of the externality. The other options do not accurately describe the purpose or function of a Pigovian tax.

A Pigovian Tax Internalizes an External Cost Because