When the production of a good creates an external cost, one method of achieving the efficient allocation is to impose a tax such that
A) MC + tax = MSC.
B) MC - tax = MSB.
C) MB + tax = MSC.
D) MB - tax = MSB.

Question

Quizplus · Accepted Answer

The correct method to achieve efficient allocation when there is an external cost is to impose a tax that equates the marginal cost (MC) plus the tax to the marginal social cost (MSC). This internalizes the external cost, aligning private costs with social costs.

When the Production of a Good Creates an External Cost