Which statement about Pigouvian tax toward the social optimum is true?

• A. It per unit equals marginal external benefit, encouraging more production.
• B. It has no relation to external costs.
• C. It per unit equals marginal external cost, reducing quantity toward the socially optimal.
• D. It is a tax on profits.

Answer: (C)

The main idea is to fix a negative externality by making producers pay for the external damage they impose. A Pigouvian tax per unit is set equal to the marginal external cost of producing one more unit. With this tax, the private marginal cost rises by the external cost, so the social marginal cost (private cost plus tax) guides the market toward the socially optimal quantity. As a result, the quantity produced falls toward the optimal level, internalizing the external damage. It targets external costs, not benefits, and it is not a tax on profits.