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CA Foundation · Business Economics · Public Finance

A chemical factory in an industrial town discharges untreated effluent into a river, harming downstream fishermen who receive no compensation. Which of the following government measures is designed to make the factory bear this cost?

A pollution tax on each unit of effluent is the correct measure. The factory creates a negative externality, so its private cost is below the social cost. The tax makes the polluter bear the external cost and internalises it, reducing excess output and pollution.

  1. AProviding a subsidy to the fishermen's cooperative for buying new boats
  2. BImposing a pollution tax on the factory per unit of effluent dischargedCorrect
  3. CDeclaring the river water a merit good
  4. DFixing a minimum support price for the factory's output

Explanation

Untreated effluent is a negative externality, because the factory's private cost is lower than the social cost. A tax on each unit of effluent (a Pigouvian tax) forces the factory to bear the external cost, so it internalises the externality. A subsidy to fishermen does not make the polluter pay, and a minimum support price would encourage more output and more pollution.

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