What is a Pigouvian subsidy, and when would a government use it?

• A. To discourage production of goods with positive externalities.
• B. To increase private cost without improving social outcomes.
• C. To increase private benefit or reduce private cost for a good with positive externalities; used to raise quantity toward the social optimum.
• D. To eliminate externalities by banning the good.

Answer: (C)

A Pigouvian subsidy corrects a situation with a positive externality. When a good provides benefits to others beyond the person who pays for it, the social payoff from consuming or producing the good is higher than the private payoff. The market on its own tends to underproduce or underconsume such goods because private decision makers don’t take the external benefits into account.

The subsidy works by increasing the private benefit (or lowering the private cost) that buyers or sellers face. By subsidizing the good, the private marginal benefit is raised toward the social marginal benefit, so the quantity rises toward the social optimum. The subsidy is designed so that the private decision aligns with the true social value, achieving a more efficient level of output.

This approach is not about discouraging production, increasing private costs, or banning the good. It’s about internalizing the external benefits to push the market toward the socially desirable quantity.