If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content

Taxes for factoring in negative externalities

AP.MICRO:
POL‑4 (EU)
,
POL‑4.A (LO)
,
POL‑4.A.1 (EK)
How to factor in negative externalities through taxation. Created by Sal Khan.

Want to join the conversation?

  • blobby green style avatar for user Dan
    Even though the externality tax removes the negative surplus above the marginal benefit curve, why doesn't this still produce deadweight loss between the market equilibrium quantity and the new, taxed quantity? Or, to phrase this in a different way, why doesn't the deadweight surplus loss to the market matter as much as removing the negative surplus from the negative externality?
    (16 votes)
    Default Khan Academy avatar avatar for user
    • mr pants teal style avatar for user Wrath Of Academy
      When he filled in the purple "triangle" he sort of glossed over that point, but the purple area is the "societal negative surplus" that's not being balanced out by a consumer surplus or producer surplus. The total societal negative surplus area is the area between the white supply curve and the green supply curve, from Q=0 to Q=3.5. The part that he shaded with slanted white stripes is societal negative surplus being zeroed out by positive consumer and producer surpluses.

      The area with the vertical yellow lines is the only producer surplus that "survives" - the rest is zeroed out by the societal negative surplus. Then there's some "surviving" societal negative surplus to the right which is the purple triangle.

      Therefore, the deadweight loss area is the part between the green and purple lines, from Q=1.5 and Q=3.5. That is the surplus area lost when we shift equilibrium left from 3.5 to 1.5. However, that deadweight loss area is being zeroed out by societal negative surplus anyway - it never counted. Ie, you're losing that area of consumer/producer surplus (which we would normally call a deadweight loss), but you're also losing a societal negative surplus of that exact same area. So it's a net of zero.
      (16 votes)
  • leaf red style avatar for user Jack McClelland
    What does "that benefit to society", that shaded triangle, the consumer surplus, really represent? Why would removing it be bad for society?
    (4 votes)
    Default Khan Academy avatar avatar for user
  • male robot donald style avatar for user Alexx Zerox
    Isn't the government in an out of itself a negative externality? Governments wage wars and can be corrupted, thus becoming a burden on the populace. The idea of negative externality being solved by another negative externality seems to be absurd to me.
    (3 votes)
    Default Khan Academy avatar avatar for user
    • purple pi purple style avatar for user Izaan Khan
      Interesting question. A negative externality is the unintended negative consequence of a particular transaction. That being said, although governments were created for the betterment of the country, they indulge in lots of misdemeanor. This is why it is best that individuals deal with the situation amongst themselves, in the spirit of voluntary cooperation. Look up "The Coase Theorem".
      (5 votes)
  • blobby green style avatar for user Nikola Gladovic
    Pigouvian tax is a tax for negative externalities, am I right?
    (3 votes)
    Default Khan Academy avatar avatar for user
  • male robot donald style avatar for user Rfplima
    If the government levied a tax of $0.02/bag, the supply curve would become the white one and we could call it "Supply + tax" curve. However, the cost of $0.02 to caused by the damaged caused by plastic bags would still exist, right? Shouldn't we build a third curve "Bags + Tax + Damage"?
    (2 votes)
    Default Khan Academy avatar avatar for user
    • ohnoes default style avatar for user Tejas
      The cost of $0.02 caused by the plastic bags still would exist, but this time it is the suppliers and the demanders who are paying the $0.02, and the money from the tax is being used to clean up the damage. We would not draw a third curve, because the tax isn't actually a cost from the point of view of the entire society. It is only a cost from the point of view of the suppliers, who actually have to pay the tax.
      (3 votes)
  • blobby green style avatar for user Mohr Alex Sam
    Doesn't inflicting a tax to off-set a negative externality only work if the funds raised from said tax are dedicated to addressing the externality directly? In other words, doesn't this theory fail in the face of human greed?
    (2 votes)
    Default Khan Academy avatar avatar for user
    • piceratops ultimate style avatar for user Markus Obrestad Randen
      A tax does increase the marginal cost of production either way if the tax is directed towards the externality or not. However your on the right track, a more affective way of taxing or subsidizing a company would be to decrease the taxation or increase the subsidizing of a company if it adheres certain criterions.
      (3 votes)
  • blobby green style avatar for user joeyjoyce7
    Is the tax imposed, imposed on the suppliers or the consumers?
    (1 vote)
    Default Khan Academy avatar avatar for user
  • leaf green style avatar for user Bae Ji-been
    In this graph, if we impose taxes on plastic bags, can we regard the tax as the compensation of the negative externalities? And, definitely optimum and equilibrium is different and we impose tax to remove the deadweight loss in that graph, new equilibrium will be the optimum(1.8, 3.5). But, can't we go back to the original status(3.5, 2) in any way?
    (2 votes)
    Default Khan Academy avatar avatar for user
    • piceratops ultimate style avatar for user Markus Obrestad Randen
      Yes the tax could be a compensation of the negative externality. This is because the Social marginal cost is greater than the firms private marginal cost. When you impose a tax this would affectively give the society money which would decrease societies costs, or the social marginal cost.
      I didn't quite get your second answer...
      (2 votes)
  • primosaur ultimate style avatar for user ekj02451
    Do negative externality taxes not seem like an extremely efficient way for the government to produce revenue, as opposed to income and capital gains taxes? You minimize the losses to society via preventing the negative surplus, while still collecting revenue for the government.

    It seems there are many things that could be taxed in this way. Carbon emissions (global warming), drug use (crime, health, and loss of productivity), and even excessive wealth (capital gaining power over politics). Why do we not see new taxes argued in this manner?
    (2 votes)
    Default Khan Academy avatar avatar for user
  • piceratops ultimate style avatar for user Eugene M Oliphant
    how does an individual, company, or industry figure out what the supply and demand curves look like? Change prices and see how much the quantity demanded changes?
    (2 votes)
    Default Khan Academy avatar avatar for user
    • male robot hal style avatar for user Nicolas Tammelin
      They can do market research to find out how many people would be interested in buying their product. The demand and supply curve are mainly just to show you the theory of how demand effect supply and vice versa. They have other means to calculate what the price of a product should be.
      (1 vote)

Video transcript

In the last video, we first thought about externalities, the negative externalities of having plastic bags around. It causes litter, it might damage animals and the environment in some way. We're assuming ... And we assumed in that video that we were able to calculate the actual external cost of a plastic bag. This two cents a bag is the impact on litter in the environment. Then we were able to figure out that if we factor this in, instead of just having the regular marginal cost cover the suppliers, if we added that marginal cost curve to the external cost, we would get a supplier plus external costs, marginal cost curve, and then we'd get what is actually the optimal price and quantity of plastic bags so that we actually do not eat into our surplus by creating all of this negative surplus where the total cost of the bags are higher than the total benefit. One thing that we did not touch on in that video, is how does this actually happen? If we just let things be, and we just had the supplier's marginal cost curve and we have the consumer's demand curve, in this case, the consumers were the supermarkets, then the equilibrium price that'll be reached will be right over here because although we're theoretically saying that there's this cost over here, the cost won't be factored in into the markets. So if you are the benevolent emperor in this society, what do you do? What do you do to get the quantity closer to this point right over here than what the equilibrium quantity will be when you don't factor in the external cost? There's a bunch of options here. You could just ban plastic bags ... ban plastic bags, you could put a quota on plastic bags, you could put a quota, so saying that more than a certain amount of bags could not be produced, or you could tax plastic bags, or you could tax plastic bags. Let's think about which of these will result in the most surplus, the most benefit to society in aggregate. One core assumption we're going to make is that this is an accurate assessment of the external cost per bag. If you were to just ban plastic bags as this benevolent emperor, maybe seemingly or hopefully benevolent emperor of this society right here, if you just banned plastic bags, what would happen? Well, then this market just won't exist. All of this surplus that could have existed, won't exist anymore, so you would actually be destroying surplus. You could say, "No, no, no ... plastic bags are horrible. They should just be outright banned. There's no amount of benefit for which plastic bags are worth using," but in that case, you're actually arguing this point right over here. You'd be arguing that, "No, it's not 2 cents a bag, it's 10 cents a bag," of negative externality, and because of that, you would have this curve shift up even more and then there's no positive quantity there and maybe a ban would be all right. But if the 2 cents is the externality, the negative externality, and if you were to ban plastic bags, then you would actually be removing, you would be removing this surplus from society. That doesn't seem like a good option. Now what about a quota? You kind of look at the study right over here and you say, "Look, the optimal amount of plastic bags is 1.9 million bags per week, so I will just say that that's most that the market can produce." But when you say that, that's assuming that you really do understand what this demand curve looks like. I just drew a straight line here just out of simplicity, and assuming that you really do understand what this marginal cost curve looks like. Throughout this playlist, we've been assuming that we kind of do understand those things, but in the real world, it's actually very hard to know exactly what the marginal cost of the curve looks like, and it's also hard to know exactly what the marginal benefit curve, or the demand curve looks like, especially because they're always changing. There's always more competitors, less competitors, more substitute products, more R&D, things are getting more efficient, less efficient; and so it's very hard to know what the true equilibrium quantity should be. A quota is difficult. We don't have quite the right information. A tax is interesting. A tax says, "Look, regardless of what the marginal cost curve really is, we're just going to shift it up by 2 cents." We saw that when we first talked about taxes. When we first talked about taxes, we talked about they're introducing a dead weight loss because you're not producing as much quantity as you would have otherwise, or as much quantity isn't being consumed. But here, a tax could actually prevent a dead weight loss because if you have a 2 cent tax, essentially adding the cost of the negative externality in the form of a tax on top of the supplier's cost right over here, you are going to cause the equilibrium quantity to be the quantity where you're not generating all of this negative surplus, and it's just a positive side effect, and once again, this is all assuming that this is the right number, but it would be a positive side effect that you would also generate some revenue for the government. What's good about the tax in this circumstance right over here, you're not assuming anything about what the marginal cost curve looks like or what the demand curve looks like. As long as you're assuming that this is the right number, the tax will always shift whatever the marginal cost curve is, it'll always shift it to the right point to intersect wherever the demand curve is at this equilibrium point, that gives us an equilibrium price and an equilibrium quantity. So if this is the right number and you put a 2 cent tax per bag, a 2 cent tax per bag, then this is probably going to be the best option in terms of optimizing the total surplus.