The government imposes a tax on an industry that produces goods creating a negative externality. Yet the industry produces more than the optimum quantity of output. This means

Question

Quizplus · Accepted Answer

If the industry is producing more than the optimum quantity of output despite the tax, it means that the tax is not high enough to internalize the external cost associated with the product. Therefore, the tax is less than the external cost associated with the product. The company should not advertise more or increase production as it will further increase the negative externality. Instead, the government should consider increasing the tax to better align the industry's production with the socially optimal level.

The Government Imposes a Tax on an Industry That Produces