CA Foundation · Business Economics · Public Finance
A government wants to discourage production of a good that imposes a negative externality, and also wants to improve the post-tax income position of low-income households. It imposes a tax on the polluting good and uses the entire proceeds to give cash transfers to poor households. Which pairing of Musgrave's functions does this policy best represent?
The tax on the polluting good is an allocation measure, since it corrects a negative externality and changes resource use. The cash transfers to poor households are a distribution measure, since they change who ends up with income. No stabilisation aim is stated in the policy.
- AAllocation (through the tax) and distribution (through the transfers)Correct
- BStabilisation (through the tax) and allocation (through the transfers)
- CDistribution (through the tax) and stabilisation (through the transfers)
- DStabilisation (through the tax) and distribution (through the transfers)
Explanation
A tax on a polluting good corrects a market failure (externality) by shifting resource use, so it is an allocation measure. Cash transfers to poor households alter the distribution of income, so they are a distribution measure. The stabilisation options are wrong because no aim relating to the business cycle, inflation or unemployment is stated.
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