AP MicroeconomicsMarket Failure & Government
Pigouvian Tax
A Pigouvian tax is a tax on a good with a negative externality, set equal to the external cost to restore the efficient quantity.
By raising the producer's marginal private cost up to the marginal social cost, it internalizes the externality. The tax reduces output to the socially optimal level and eliminates deadweight loss. A carbon tax is a common example.
Formula / Example
Optimal tax = marginal external cost at the efficient quantity.
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