Question

Suppose the figure to the right represents the production of a manufactured good. Production of this good generates volatile organic compounds, which are a type of air pollution. As a result, the cost of production to society is greater than the private cost of production. The marginal private cost of production is represented by MC, and the marginal social cost is represented by MC2?

550
500
MC.2
450 400
Suppose the government decides to impose a Pigovian tax to bring about an efficient level of output. What size should the tax be?
The government should levy a tax of $per ton produced.Enter your response as a whole number.)
300 250 108 200
MC,
150
100
50 0-
MBT 4 6 8 10 121416 18 20 Quantity (millions of tons per year)

Answer 1

A Pigovian tax should be set equal to the difference between the MC2 and MC at the socially optimal quantity of goods produced, to internalize the externality and correct for the socially higher costs due to pollution.

Step-by-step explanation:

To determine the size of a Pigovian tax that would correct for the externalities caused by volatile organic compounds, we need to look at the difference between the marginal private cost (MC) of production and the marginal social cost (MC2) of production. The tax should be set at the level where the MC equals the marginal benefit (MB), which would internalize the externality and bring production to a socially optimal level. This would be represented by the vertical distance between the MC and MC2 curves at the efficient level of output.

In the context provided, although there aren't specific numbers given for the marginal costs or the amounts by which the MC2 exceeds the MC, the principle would be to impose a tax equal to the external cost per unit. This tax would be set to the difference between MC2 and MC at the socially optimal quantity of goods produced. Therefore, if the optimal level of production is at a point where the MC is $200 and the MC2 is $250, the tax should be $50 per unit.