Taxes for factoring in negative externalities | Microeconomics | Khan Academy

How to factor in negative externalities through taxation

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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.