Internalization of externality the above method of

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Internalization of externalityThe above method of dealing on externalitiescategorized into to parts.Regulate behavior and Internalize the externalities
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Pigovian tax to internalize externalityThe dead weight lossdead weight lossis associated with the negative negative production externalitiesproduction externalitiesPigovian taxes: The government can internalize the externalities by imposing a tax on the producer.The tax shifts private cost supply up to social cost supply and eliminates the dead-weight loss.Internalize an externalitiesInternalize an externalitiesmeans to alter incentives so that people take account of the external effects of their actions.Pigovian taxes are enacted to correct the effects of the negative externalities
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Cont. Let us assume we have paper production firm/industry. Suppose corrective taxes were levied by the government on producers of paper to internalize the negative externalitythey cause during production.The MEC = $10 (see fig 3.1 below)For internalization, the tax to be imposed must be equal to the MEC= T=MEC = $10 per ton of paper production.Paper producers will include this tax in their cost functionsand it increases their MPC of production.Consequently, the supply (MPC) curve shifts up to the left from S to S’ in fig. 3.3, where S’ reflects the full marginal social cost(MSC) of producing paper.
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Fig. 3.5 Effects of a Corrective Tax (Pigouvian Tax) MSCMPCPQ tax Qe Q Pe P
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Fig. 3.5 Effects of a Corrective Subsidy (Pigouvian Tax) MSC MSB
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Cont.They would demand the paper plant to stop polluting the river as the river now belongs to them.The paper plant has two options: One is to reduce the pollution by closing down the One is to reduce the pollution by closing down the plant. plant. The other option is to bargain with them and pay a The other option is to bargain with them and pay a compensation (say $100 per ton of paper produced)
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