When producers operate in a market characterized by negative externalities, a tax that forces them to internalize the externality will
A)give sellers the incentive to account for the external effects of their actions.
B)increase demand.
C)increase the amount of the commodity exchanged in market equilibrium.
D)restrict the producers' ability to take the costs of the externality into account when deciding how much to supply.

Question

Quizplus · Accepted Answer

A tax on producers will increase their costs, giving them an incentive to reduce their output, and thereby reduce the negative externality. This tax will force producers to account for the external effects of their actions, leading to a more efficient allocation of resources. This option also rules out choices B, C, and D as they all suggest that the tax will have a positive effect on the market outcome, which is not always the case.

When Producers Operate in a Market Characterized by Negative Externalities