A Pigouvian tax is designed to...

• A. It is a subsidy to producers to encourage production
• B. It is a tax on goods with external benefits to increase consumption
• C. It is a tax intended to correct negative externalities by aligning private and social costs
• D. It is a tax that funds public goods

Answer: (C)

A Pigouvian tax is designed to correct a negative externality by aligning private costs with social costs. When producing or consuming a harmful activity imposes costs on others, the market price ignores those effects, so too much of the good is produced or consumed. Imposing a tax equal to the marginal external damage raises the private cost faced by the producer or consumer, effectively turning private costs into social costs. This reduces the quantity toward the socially optimal level and helps welfare by internalizing the external harm. It’s not about subsidies or goods with external benefits, which would involve different policies; its purpose is to reflect the true social cost in the price.