An optimal tax on pollution would result in which of the following?

• A. The marginal social cost of pollution equals the marginal social benefit of pollution reduction.
• B. Firms are incentivized to increase pollution to maximize profits.
• C. The total social cost of pollution is eliminated.
• D. The marginal private cost of pollution equals the marginal private benefit of pollution.

Answer: (A)

Verified step by step guidance

1. Understand the concept of an optimal tax on pollution, which is designed to correct the market failure caused by negative externalities, such as pollution.
2. Recall that pollution creates a divergence between private costs and social costs, where the marginal social cost (MSC) includes both the marginal private cost (MPC) and the external cost imposed on society.
3. Recognize that an optimal tax aims to internalize the externality by making firms face the true social cost of their pollution, aligning their private incentives with social welfare.
4. Identify that the optimal tax level is set where the marginal social cost of pollution equals the marginal social benefit of pollution reduction, ensuring that the cost of reducing pollution balances the benefits gained from that reduction.
5. Note that this equilibrium does not necessarily eliminate all pollution or total social cost but ensures an efficient outcome where the marginal costs and benefits are equalized.