Consider a market in which there is an external cost. A tax can be used to arrive at the efficient market equilibrium because the tax will
A) increase demand for the good.
B) decrease demand for the good.
C) decrease supply of the good.
D) increase supply of the good.

Question

Quizplus · Accepted Answer

A tax on a good with an external cost (such as pollution from production) effectively increases the cost of producing that good. This is represented in economic models as a leftward shift in the supply curve, indicating a decrease in supply at any given price, as producers account for the higher production costs due to the tax. This helps internalize the external cost, leading to a more efficient market outcome by reducing the quantity produced and consumed to a level that reflects the true social cost of the good.

Consider a Market in Which There Is an External Cost