When the government taxes a firm that generates external costs, the firm will produce
A) more units of output than before the tax was imposed in order to continue maximizing profits.
B) the same number of units of output as before the tax was imposed to continue maximizing profits.
C) fewer units of output than before the tax was imposed in order to continue maximizing profits.
D) either more or fewer units of output than before the tax was imposed depending upon what happens to the profit-maximizing level of output.

Question

Quizplus · Accepted Answer

When the government taxes a firm for generating external costs, it increases the firm's production costs. To continue maximizing profits under these new conditions, the firm will typically produce fewer units of output, as the marginal cost of producing each additional unit now includes the tax. This adjustment aims to align the firm's private costs with the social costs of its production.

When the Government Taxes a Firm That Generates External Costs