When the production of a good creates an external cost, to achieve the efficient quantity governments can set taxes (T) such that _______.
A) MC = MSC + T
B) MSC = MC + T
C) MSC = MC - T
D) T = MC + MSC

Question

Quizplus · Accepted Answer

The correct choice is B) MSC = MC + T. This equation represents the principle that to achieve the efficient quantity of a good that generates an external cost, the government can impose a tax (T) that aligns the marginal social cost (MSC) with the marginal cost (MC) to the producer. The tax essentially internalizes the external cost, making the producer account for the broader social impacts of their production.

When the Production of a Good Creates an External Cost