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

Question

BlackTom AI · Accepted Answer

Consider the question about which market situation is addressed by Pigovian taxes and direct controls.
Option 1: Positive externalities. In cases of positive externalities, the market underproduces the social benefit, and policy typically uses subsidies or public provision to encourage positive spillovers. Pigovian taxes and direct controls are not used for this situation, so this choice is incorrect.
Option 2: Negative externalities. This is the core scenario where an activity imposes costs on others not reflected in private prices. Pigovian taxes raise the private cost to align private incentives with social costs, and direct controls (like emission standards or quotas) limit the activity. These tools specifically target external damages, making this option correct.
Option 3: Pure monopoly. Monopoly concerns market power and price setting, not external damages per se. While regulation can address monopolistic issues, Pigovian taxes and direct controls are not the standard remedy for monopoly power, so this choice is incorrect.
Option 4: Competitive markets. In perfectly competitive settings, prices already reflect marginal social costs in many cases; there is typically less justification for Pigovian interventions unless externalities exist. Since the question asks about a market situation needing these tools, this option is not appropriate for the general use of Pigovian taxes and direct controls, making it incorrect.
Summing up the reasoning: Pigovian taxes and direct controls are designed to correct the inefficiencies arising from negative externalities, by internalizing external costs or directly limiting harmful activities, while the other options describe scenarios where these tools are not the standard or most appropriate solution.

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

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