Question

Suppose that electricity producers create a negative externality equal to $5 per unit. further suppose that the government imposes a $5 per-unit tax on the producers. what is the relationship between the after-tax equilibrium quantity and the socially optimal quantity of electricity to be produced?
a. they are equal.
b. the after-tax equilibrium quantity is greater than the socially optimal quantity.
c. the after-tax equilibrium quantity is less than the socially optimal quantity.
d. there is not enough information to answer the question.

Answer 1

A.

If the negative externality was $5, that would be saying that the marginal social cost was $5 above the marginal private cost. Therefore by placing a $5 tax, the marginal private cost would shift $5 above, which is where the marginal social cost is, thus they are equal.