Question

Sequence the Pigouvian externality corrections: A. Identify the external cost, B. Measure marginal external damage, C. Compute marginal social cost, D. Tax equals to marginal external damage, E. Welfare improves after corrections.

• A. A, B, C, D, E
• B. A, B, C, E, D
• C. A, E, C, B, D
• D. C, A, B, D, E

Hint:

Pigouvian correction follows: identify external cost, measure damage, compute social cost, impose tax, and improve welfare.

Answer 1

The Correct Option is A

Concept: Pigouvian tax is imposed to correct negative externalities. It makes private decision makers consider the external cost imposed on society.

Step 1: Identify the external cost.
First, we must identify whether production or consumption creates an external cost. \[ A = \text{Identify external cost} \]

Step 2: Measure marginal external damage.
After identifying the external cost, we measure the extra damage caused by one additional unit. \[ B = \text{Measure marginal external damage} \]

Step 3: Compute marginal social cost.
Marginal social cost includes private marginal cost and marginal external damage. \[ MSC = MPC + MED \] \[ C = \text{Compute marginal social cost} \]

Step 4: Set Pigouvian tax equal to marginal external damage.
The corrective tax should be equal to marginal external damage. \[ \text{Pigouvian Tax}=MED \] \[ D = \text{Tax equals marginal external damage} \]

Step 5: Welfare improves after correction.
When the externality is internalized, overproduction is reduced and social welfare improves. \[ E = \text{Welfare improves} \] Thus, the correct sequence is: \[ A, B, C, D, E \]