When the production of a good creates an external cost, by setting the tax rate equal to the _______ , firms can be made to behave in the same way as they would if they bore the cost of the externality directly.
A) marginal private benefit
B) marginal external cost
C) marginal social cost
D) marginal social benefit

Question

Quizplus · Accepted Answer

The correct answer is B) marginal external cost. When a tax is set equal to the marginal external cost, it internalizes the externality by making firms face the full cost of their production, including the external costs they impose on others. This aligns their private costs with the social costs, leading to a more efficient outcome.

When the Production of a Good Creates an External Cost