Question

16. If the government taxes an industry that creates pollution, the tax

i.          increases the pollution.

ii.         decreases the price of the product produced by the firms.

iii.         decreases the quantity of the good produced.

1. i only.
2. Ii only
3. iii only.
4. ii and iii.
5. i and iii.
6. i, ii, and iii.

Answer 1

The correct answer is (C) iii only - decreases the quantity of goods produced.

If the government levies a tax on pollution, it increases the polluter's private cost. The polluter now has an incentive to generate less pollution. That is, the higher cost of polluting activity due to taxes acts as a disincentive for greater production. Thus taxes make it more expensive for firms to produce the good or service generating the externality, thus providing an incentive to produce less of it.

Option (i) is not true since taxes decrease quantity levels produced (as exlained above) and amount of pollution is directly related to level of quantity produced. Thus as quantity produced decreases the pollution level also decreases.

Option (ii) is incorrect a tax increases the marginal cost of producing the product. This shifts the supply curve leftward, that is, the same quantity is supplied at a higher price at each level. That is, a tax increases the price of the product produced by the firms.