What describes a Pigouvian tax?

• A. It is a per-unit tax equal to the marginal external cost at the socially optimal quantity.
• B. It is a tax on profits to fund social programs.
• C. It is a lump-sum tax unrelated to production.
• D. It is a per-unit subsidy to reduce costs.

Answer: (A)

A Pigouvian tax is a per-unit tax designed to internalize the external costs of production. It is set equal to the marginal external cost at the socially optimal quantity, so producers face the true social cost of their output. This shifts the private marginal cost upward by the amount of the external damage, steering the market toward the socially efficient point where marginal benefit equals marginal social cost. By charging exactly the MEC at the socially optimal quantity, the tax reduces production to the efficient level and eliminates the deadweight loss from the negative externality. The other descriptions describe taxes on profits, lump-sum charges, or subsidies, none of which specifically price the external damage or fix the externality.