Suppose that production of a good creates a negative externality.An excise tax equivalent to the difference between the marginal social cost and the marginal private cost of production can correct the inefficiency.

Question

Quizplus · Accepted Answer

By levying an excise tax equivalent to the difference between the marginal social cost and marginal private cost, production of the good becomes relatively more expensive for the producer. This encourages them to produce less and internalize the negative externality, leading to a more efficient allocation of resources. Therefore, an excise tax can correct the inefficiency caused by negative externalities.

Suppose That Production of a Good Creates a Negative Externality