In order to internalize the externality due to pollution, the government should impose a tax based on

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Quizplus · Accepted Answer

Imposing a tax based on the economic damage associated with the pollution is the most effective way to internalize the externality. This tax would incentivize firms to reduce their pollution levels to avoid paying the tax, leading to a more socially optimal level of pollution. Taxing based on the physical amount of pollution or the size of the firm may not accurately reflect the economic damage caused by the pollution. Taxing based on the value of the pollution-causing business activity also may not accurately reflect the economic damage and may discourage valuable economic activity.

In Order to Internalize the Externality Due to Pollution, the Government