If a pollution tax imposed on a firm is smaller than the external cost
A) the externality is completely internalized.
B) the social production cost increases by the amount of the pollution tax.
C) the pollution tax transfers the full cost borne by people outside the firm back to the firm itself.
D) the firm is producing too much from society's point of view.

Question

Quizplus · Accepted Answer

If the pollution tax imposed on a firm is smaller than the external cost, it means that the firm is not paying the full cost of the pollution it is creating. Therefore, the firm has an incentive to produce more than what would be socially optimal, resulting in a negative externality on the rest of society. Thus, the correct answer is (D) the firm is producing too much from society's point of view.

If a Pollution Tax Imposed on a Firm Is Smaller