Question

In the presence of a negative externality, a tax on the offending good t = MEC (marginal external cost) will yield the socially optimal level of output (Q*).

a. True
b. False

Answer 1

In the presence of a negative externality, a tax on the offending good can lead to the socially optimal level of output, provided that the tax is equal to the Marginal External Cost (MEC).

Step-by-step explanation:

In the presence of a negative externality, a tax on the offending good can lead to the socially optimal level of output, provided that the tax is equal to the Marginal External Cost (MEC). This is because the tax internalizes the externality by making firms face the full social cost of production. By increasing the cost of production, the tax encourages firms to reduce their output to the socially optimal level where the Marginal Social Cost (MSC) equals the Marginal Social Benefit (MSB).

For example, suppose there is a negative externality from a good like pollution. By imposing a tax equal to the MEC of pollution, the government can discourage firms from producing at a level that generates excessive pollution. The tax increases the cost of production and reduces the quantity of the good produced, resulting in a socially optimal outcome.