CA Foundation · Business Economics · Public Finance
A paper mill's marginal private cost of producing a tonne of paper is Rs 600. Each tonne also causes pollution damage of Rs 150 to nearby residents. If the government wants to internalise this externality through a per-unit tax, what tax per tonne should it impose, and what will the marginal social cost be at that point?
The tax should equal the external damage of Rs 150 per tonne. Marginal social cost is private cost Rs 600 plus external cost Rs 150, giving Rs 750. The tax makes the producer's cost equal to the full social cost.
- ATax of Rs 150; marginal social cost Rs 750Correct
- BTax of Rs 600; marginal social cost Rs 1,200
- CTax of Rs 150; marginal social cost Rs 600
- DTax of Rs 750; marginal social cost Rs 750
Explanation
A corrective (Pigouvian) tax equals the marginal external cost, which is Rs 150 per tonne. Marginal social cost = MPC + external cost = 600 + 150 = Rs 750. With the tax, the producer's cost becomes 600 + 150 = 750, equal to MSC. Charging Rs 750 would tax the producer's own cost too, which is wrong.
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