Externalities and Market Failure

Running head: EXTERNALITIES AND MARKET FAILURE
Externalities and Market Failure
Name of the Student
Name of the University
Student ID

EXTERNALITIES AND MARKET FAILURE1
Table of Contents
Answer 1....................................................................................................................................2
Answer 2....................................................................................................................................3
Answer 3....................................................................................................................................3
Answer 4....................................................................................................................................4
References..................................................................................................................................5

EXTERNALITIES AND MARKET FAILURE2
Answer 1
Market failure is a situation of an economy where distribution of goods are not done
efficiently and the individual benefits occurs at the cost of others who are not enjoying or
willing to enjoy the benefits of the goods (Brim, 2017). Thus, market failure takes place when
the price of a good fails to account all the costs of the good. Thus, in order to address or
account all the cost of goods produced or consumed a corrective tax is imposed on the price
goods to solve the condition of market failure and the tax is called Pigovian tax (Stitglitz,
2015). Thus, Pigovian tax is a corrective measure of market failure.
It is stated in the question that the external cost of driving cars ion $5000, therefore, it
is clear that driving cars causes market failure by generating negative externality. Thus, to
solve the market failure occurring due to driving cars a tax of $5000 should be charged for
driving cars, which is equivalent to the social cost generated due to driving cars. Graphical
illustration of the same is shown below.
Figure 1:
Pigovian Tax