CA Foundation · Business Economics · Public Finance
A private firm producing steel causes pollution. Its marginal private cost is Rs 600 per tonne at the market output. The marginal external cost imposed on society is Rs 150 per tonne. The government wishes to correct the market failure with a per-unit tax. What tax per tonne would make the firm's marginal cost equal to the marginal social cost at this output?
The corrective tax is Rs 150 per tonne. Marginal social cost is Rs 750, being Rs 600 private cost plus Rs 150 external cost. A tax equal to the marginal external cost raises the firm's cost to the social level and internalises the externality.
- ARs 750
- BRs 450
- CRs 150Correct
- DRs 600
Explanation
Marginal social cost = marginal private cost + marginal external cost = 600 + 150 = Rs 750. The firm must be made to face Rs 750, so the tax must equal the external cost of Rs 150 per tonne. Rs 750 wrongly taxes the whole social cost, and Rs 450 wrongly subtracts the external cost from the private cost.
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