Suppose the government imposes an emissions tax of $t on each unit of pollution produced by a firm.Under which of the following circumstances would the tax rate be set too high to achieve allocative efficiency?

Question

Quizplus · Accepted Answer

Allocative efficiency occurs when the marginal social cost (MSC) of production equals the marginal social benefit (MSB) to society. In the case of pollution, there is a negative externality, where the MSC includes not only the private marginal cost of production but also the marginal external cost of pollution imposed on society. By imposing an emissions tax equal to the marginal external cost of pollution, the MSC faced by the firm will include both these costs, and the market will achieve allocative efficiency. If the tax rate is set too low, the firm will continue to produce more pollution than is socially optimal, but if the tax rate is set too high, the firm may be unable to stay in business. However, if the tax rate is greater than the marginal external cost of pollution, the firm will have an incentive to reduce its emissions below the socially optimal level, which would result in a deadweight loss to society, and allocative efficiency would not be achieved.

Suppose the Government Imposes an Emissions Tax of $T on Each