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CA Foundation · Business Economics · Public Finance

A chemical factory in an industrial area discharges untreated effluent into a river, harming the fishing community downstream. The factory's private cost of production is lower than the true cost to society. Which government intervention is most directly aimed at making the factory bear this cost?

Imposing a pollution tax on each unit of output is correct. The factory creates a negative externality, so its private cost is below the social cost. A Pigouvian tax makes the factory bear the external damage, reducing output towards the socially efficient level, whereas a subsidy would worsen pollution.

  1. AGranting a production subsidy to the factory
  2. BImposing a pollution tax on each unit of outputCorrect
  3. CProviding free river water to the fishing community
  4. DReducing the corporate income tax rate

Explanation

The factory creates a negative externality, so social cost exceeds private cost. A tax per unit of output (a Pigouvian tax) raises the private cost to the social level and internalises the externality. A subsidy would encourage more output and more pollution, worsening the problem.

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