What is a Pigouvian subsidy and when is it used?

• A. Subsidy for any good regardless of externalities.
• B. Payment to increase the quantity of a good that generates positive externalities, aligning private incentives with social benefits.
• C. Tax to reduce production of a polluting good.
• D. Price ceiling on a good with external benefits.

Answer: (B)

A Pigouvian subsidy is a government payment per unit to a good that creates positive externalities. Because people don’t capture the full social benefits in their private decisions, the market tends to under-provide such goods. The subsidy adds to the private benefit (or lowers the private cost), so the quantity exchanged rises toward the socially optimal level. In theory, the subsidy equals the marginal external benefit at that socially efficient quantity, helping private incentives align with social welfare.

This is used whenever there are positive externalities—think vaccinations, education, or research and development—where society gains more from additional units than the market price alone reflects. It’s not a general subsidy (which would apply to any good), not a tax (which targets negative externalities), and not a price ceiling (which restricts price and can create shortages).