Pigovian Taxes and Cigarettes Essay

1048 Words Apr 22nd, 2013 5 Pages
Q 1. Cigarettes are often cited in economics texts as an example of a particular type of market failure. Identify that market failure, and illustrate the failure using an appropriate diagram.
Ans. Cigarettes represents a market failure of externatilities. They are sited as negative externality as they affect the wellbeing of the bystander and the person neither pays nor receives any compensation for that negative effect.
A smoker enjoys the puff of the smoke and the bystander inhales the fumes of the cigarette and indirectly suffers health hazards. And if the bystander fells sick because of the smoke as one reason he will not be compensated by the smoker for the ill- health and therefore, smoking has a negative impact on a person who
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Compared to the command and control approach to pollution control, the tradable emissions allowance system is more efficient, because firms with low costs of pollution control would pollute the least and sell their extra permits to other firms with higher costs of pollution control.
Command and control approaches are based on the uniform reductions i.e. a set of amount of reduction of pollution by all the firms despite the size and amount of pollution produced. This is ineffective in targeting firms producing high pollution as it does not consider the cost in reducing the pollution for each firm. Often, the firm which must undertake high reductions are those who can do it with ease as compared to other firms, by this the pollution is reduced at a lesser overall cost.
Pigovian taxes are levied on firms for every unit of pollution. The firms which would opt for the tax will be the ones who find it more expensive to reduce the pollution. All other firms will make policies to reduce their pollution, which would be cheaper than paying the tax. Total surplus is maximal (optimal) when marginal social benefit equals marginal cost. A Pigovian tax on consumers lowers their marginal benefit to equal MSB, and so equilibrium quantity is optimal.

S = MC
D = MB

0
5,000
10,000
15,000

Buyers’ price of a pack of cigarettes
Quantity of cigarettes
B
$14
12
10
8
6
4
2
MSB

Pigovian tax = $4

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