To internalize externality(refer to the word"externality"), Pigou considers
companies that have mistakes should be punished. He proposed a classic method
to make people pay for the externality cost is to levy a Pigovian taxes which
is equal to the negative externality, as is shown in figure 1. Producers who
overproduce are the sides that have mistakes, so they should be punished in the
way of turning tax. By charging producers the tax, the externality cost is
internalized. When imposed Pigovian tax, producers have an incentive to reduce
their production because their cost is increased and profit will be decreased (http://en.wikipedia.org/wiki/Pigovian_tax).
However, in
practice, there exist difficulties to implement Pigovian tax. The amount of
Pigovian tax is determined by the equilibrium where marginal social cost equals
to marginal benefit. This requires us to know the exact monetary value of the loss.
But it is hard to calculate accurate loss because theloss
is usually very complicated and uncertain. The compromising way is to estimate an
approximate loss and make the estimated value be the tax. The closer the
estimated value is to externality cost, the better the effect of the tax will
be.
companies that have mistakes should be punished. He proposed a classic method
to make people pay for the externality cost is to levy a Pigovian taxes which
is equal to the negative externality, as is shown in figure 1. Producers who
overproduce are the sides that have mistakes, so they should be punished in the
way of turning tax. By charging producers the tax, the externality cost is
internalized. When imposed Pigovian tax, producers have an incentive to reduce
their production because their cost is increased and profit will be decreased (http://en.wikipedia.org/wiki/Pigovian_tax).
However, in
practice, there exist difficulties to implement Pigovian tax. The amount of
Pigovian tax is determined by the equilibrium where marginal social cost equals
to marginal benefit. This requires us to know the exact monetary value of the loss.
But it is hard to calculate accurate loss because theloss
is usually very complicated and uncertain. The compromising way is to estimate an
approximate loss and make the estimated value be the tax. The closer the
estimated value is to externality cost, the better the effect of the tax will
be.
image source: Qi Shen
by Qi
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