A corrective tax (Pigovian tax) is designed to

• A. It subsidizes the external effect
• B. True that it internalizes the external cost by aligning private and social costs
• C. It reduces government revenue
• D. It ignores the external cost

Answer: (B)

Pigovian taxes are meant to make private decisions take into account the cost that an activity imposes on others. When a negative externality exists, the social cost of producing a good is higher than the private cost faced by the producer, so the market tends to overproduce. A corrective tax set equal to the external cost per unit raises the private marginal cost by exactly that external amount, so the private decision makers now face the social cost as part of their costs. This aligns private and social costs, nudging the market toward the socially efficient quantity where marginal benefit equals the social marginal cost. The tax also yields government revenue, but the main idea is internalizing the externality, not subsidizing it or ignoring it.