Pigovian taxes and direct controls are two government solutions for which market situation?

• A. Markets with negative externalities
• B. Markets with perfect competition
• C. Markets with public goods
• D. Markets with increasing returns to scale

Answer: (A)

Verified step by step guidance

1. Identify the nature of the problem that Pigovian taxes and direct controls aim to address. Both are government interventions designed to correct market failures.
2. Understand that Pigovian taxes are imposed to internalize external costs, meaning they make producers or consumers pay for the negative side effects (externalities) their actions impose on others.
3. Recognize that direct controls involve regulations or limits set by the government to restrict harmful activities causing negative externalities.
4. Recall the types of market situations: perfect competition (efficient markets without externalities), public goods (non-excludable and non-rival goods), increasing returns to scale (cost advantages with scale), and negative externalities (costs imposed on third parties).
5. Conclude that since Pigovian taxes and direct controls are designed to reduce or eliminate negative externalities, the correct market situation they address is 'Markets with negative externalities'.