efficient solution would be at the point where MB(Q) = MSC(Q). Thus the free competitive market leads to the excessive negative externality causing activities. 8 Inefficiency of Competition with Externality
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Policy Solutions Pigouvian Taxes or subsidiesThe government can solve the problem caused by a negative externality by imposing a Pigovian tax (t = MEC at Qopt) on the producer (or consumer). This tax (on producer) will increase the MC of production of the factory by the tax amount and as a result shifts the MC of production (after tax) to the left by the tax amount. This tax induces the producer to reduce the equilibrium quantity to Qoptimal, and thus eliminates the DWL. 11