ECON 1 Lecture Notes - Lecture 13: Pigovian Tax, Coase Theorem, Ecotax
Chapter 10: Externalities
- Corrective tax: tax designed to induce private decision-makers to take account of the social costs that
arise from a negative externality
o Also called Pigouvian taxes
- Pigouvian tax: tax on a good with external costs (e.g. $1/gallon tax on gasoline)
o The ideal corrective tax = external cost
- Pigouvian subsidy: a subsidy on a good with external benefits (3.g. $10/shot subsidy for flu shots)
o For activities with positive externalities, ideal corrective subsidy = external benefit
- Other taxes and subsidies distort incentives and move economy away from the social optimum
- Corrective taxes and subsidies:
o Alig priate ieties ith soiet’s iterests
o Make private decision-makers take into account the external costs and benefits of their actions
o Move economy toward a more efficient allocation of resources
- Different firms have different costs of pollution abatement
- Efficient outcome: firms w the lowest abatement costs reduce pollution the most
- A pollution tax is efficient:
o Firms w low abatement costs will reduce pollution to reduce their tax burden
o Firms w high abatement costs have greater willingness to pay tax
- In contrast, a regulation requiring all firms to reduce pollution by a specific amount not efficient
- Corrective taxes are better for the environment
o The corrective tax gives firms an incentive to continue reducing pollution as long as the cost of
doing so is less than the tax
o If a cleaner technology becomes available, the tax gives firms an incentive to adopt it
o In contrast, firms have no incentive for further reduction beyond the level specified in a
regulation
- When externalities are significant, the market equilibrium is no longer efficient
- What can be done to resolve this problem?
o Private solutions
▪ The coase theorem
o Government solutions
▪ Taxes and subsidies
▪ Command and control
▪ Tradable allowances
- In certain situations, the private sector can resolve externalities
- Solving problems requires time and effort
- Transaction costs: all the costs necessary to reach an agreement
- Types of private solutions:
o Moral codes and social sanctions
o Charities
o Contracts between market participants and the affected bystanders
- The Coase Theorem
o If transaction costs are law and property rights are clearly defined, private bargains will ensure
that the market equilibrium is efficient even when there are externalities
o if priate parties a ostlessl argai oer the alloatio of resoures, the a sole the
eteralities prole o their o
- Why private solutions do not always work
o Transaction costs: transaction costs may make it impossible to reach a mutually beneficial
agreement
o Even if a beneficial agreement is possible, each party may hold out for a better deal
find more resources at oneclass.com
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Document Summary
Corrective tax: tax designed to induce private decision-makers to take account of the social costs that arise from a negative externality: also called pigouvian taxes. Pigouvian tax: tax on a good with external costs (e. g. /gallon tax on gasoline: the ideal corrective tax = external cost. Pigouvian subsidy: a subsidy on a good with external benefits (3. g. /shot subsidy for flu shots: for activities with positive externalities, ideal corrective subsidy = external benefit. Other taxes and subsidies distort incentives and move economy away from the social optimum. Corrective taxes and subsidies: alig(cid:374) pri(cid:448)ate i(cid:374)(cid:272)e(cid:374)ti(cid:448)es (cid:449)ith so(cid:272)iet(cid:455)"s i(cid:374)terests, make private decision-makers take into account the external costs and benefits of their actions, move economy toward a more efficient allocation of resources. Different firms have different costs of pollution abatement. Efficient outcome: firms w the lowest abatement costs reduce pollution the most.
