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Course: Microeconomics>Unit 9

Lesson 1: Externalities

Taxes for factoring in negative externalities

How to factor in negative externalities through taxation. Created by Sal Khan.

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• Even though the externality tax removes the negative surplus above the marginal benefit curve, why doesn't this still produce deadweight loss between the market equilibrium quantity and the new, taxed quantity? Or, to phrase this in a different way, why doesn't the deadweight surplus loss to the market matter as much as removing the negative surplus from the negative externality?
• When he filled in the purple "triangle" he sort of glossed over that point, but the purple area is the "societal negative surplus" that's not being balanced out by a consumer surplus or producer surplus. The total societal negative surplus area is the area between the white supply curve and the green supply curve, from Q=0 to Q=3.5. The part that he shaded with slanted white stripes is societal negative surplus being zeroed out by positive consumer and producer surpluses.

The area with the vertical yellow lines is the only producer surplus that "survives" - the rest is zeroed out by the societal negative surplus. Then there's some "surviving" societal negative surplus to the right which is the purple triangle.

Therefore, the deadweight loss area is the part between the green and purple lines, from Q=1.5 and Q=3.5. That is the surplus area lost when we shift equilibrium left from 3.5 to 1.5. However, that deadweight loss area is being zeroed out by societal negative surplus anyway - it never counted. Ie, you're losing that area of consumer/producer surplus (which we would normally call a deadweight loss), but you're also losing a societal negative surplus of that exact same area. So it's a net of zero.
• What does "that benefit to society", that shaded triangle, the consumer surplus, really represent? Why would removing it be bad for society?
• Isn't the government in an out of itself a negative externality? Governments wage wars and can be corrupted, thus becoming a burden on the populace. The idea of negative externality being solved by another negative externality seems to be absurd to me.
• Interesting question. A negative externality is the unintended negative consequence of a particular transaction. That being said, although governments were created for the betterment of the country, they indulge in lots of misdemeanor. This is why it is best that individuals deal with the situation amongst themselves, in the spirit of voluntary cooperation. Look up "The Coase Theorem".
• Pigouvian tax is a tax for negative externalities, am I right?
• Yes, it is correcting for the negative externality.
• If the government levied a tax of \$0.02/bag, the supply curve would become the white one and we could call it "Supply + tax" curve. However, the cost of \$0.02 to caused by the damaged caused by plastic bags would still exist, right? Shouldn't we build a third curve "Bags + Tax + Damage"?
• The cost of \$0.02 caused by the plastic bags still would exist, but this time it is the suppliers and the demanders who are paying the \$0.02, and the money from the tax is being used to clean up the damage. We would not draw a third curve, because the tax isn't actually a cost from the point of view of the entire society. It is only a cost from the point of view of the suppliers, who actually have to pay the tax.
• Doesn't inflicting a tax to off-set a negative externality only work if the funds raised from said tax are dedicated to addressing the externality directly? In other words, doesn't this theory fail in the face of human greed?
• A tax does increase the marginal cost of production either way if the tax is directed towards the externality or not. However your on the right track, a more affective way of taxing or subsidizing a company would be to decrease the taxation or increase the subsidizing of a company if it adheres certain criterions.
• In this graph, if we impose taxes on plastic bags, can we regard the tax as the compensation of the negative externalities? And, definitely optimum and equilibrium is different and we impose tax to remove the deadweight loss in that graph, new equilibrium will be the optimum(1.8, 3.5). But, can't we go back to the original status(3.5, 2) in any way?
• Yes the tax could be a compensation of the negative externality. This is because the Social marginal cost is greater than the firms private marginal cost. When you impose a tax this would affectively give the society money which would decrease societies costs, or the social marginal cost.
• Do negative externality taxes not seem like an extremely efficient way for the government to produce revenue, as opposed to income and capital gains taxes? You minimize the losses to society via preventing the negative surplus, while still collecting revenue for the government.

It seems there are many things that could be taxed in this way. Carbon emissions (global warming), drug use (crime, health, and loss of productivity), and even excessive wealth (capital gaining power over politics). Why do we not see new taxes argued in this manner?
• how does an individual, company, or industry figure out what the supply and demand curves look like? Change prices and see how much the quantity demanded changes?