Which policy is a standard Pigovian remedy for a negative externality?

• A. A per-unit subsidy equal to the marginal external benefit
• B. A per-unit tax equal to the marginal external cost
• C. A price floor on the good
• D. A maximum price regulation

Answer: (B)

A Pigovian remedy for a negative externality is to impose a per-unit tax equal to the marginal external cost. When a production process imposes costs on others, the true social cost of each unit is the private cost plus those external costs. By charging a tax that matches the external cost at the socially efficient output, producers face the true, social cost of their production. This internalizes the externality, shifting the private marginal cost upward by the amount of the externality and moving the market toward the quantity where social marginal cost equals the marginal benefit.

A subsidy would do the opposite, encouraging more production and making the externality worse. Price controls like a price floor or a price ceiling don’t specifically address the external cost—they alter prices and quantities but fail to align private incentives with social costs.