This is the simple idea behind a Pigouvian tax. If we know the marginal value of the damage caused by a negative externality we can tax the firm or consumer that amount. Such a tax assures that private and social marginal costs are the same and thus the externality is fully considered.
For a positive externality, we could subsidize the behavior which generates
the positive externality by the marginal value of the external benefit, again causing the decision maker to face the full social costs of her decisions. In what follows
we briefly examine these problem graphically.
Copyright © 1995-2004 OnLineTexts.com, Inc. - All Rights Reserved