Page 366 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Unit-24: Pigovian Welfare Economics and Externalities

Self Assessment Notes

State whether the following statements are True/False:
9. According to Pigou, due to external effects there is no maximum social welfare.
10. Compared to personal costs and benefits, social costs are more and profits are less.
11. Pigou does not consider national benefit as an indicator of welfare.
12. Like Pigou, Bomol suggests that by the method of taxes and subsidy, external effects can be controlled.
Remedial measures—Pigou preferred state interference to bring equality in personal and social costs
and benefits. Pigou suggests introducing taxes, economic assistance, and other social control measures
to stop the differences in the cost and benefit that occur because of production and consumption
externalities. We describe this below:
1. Social control measures: Primarily, Pigou suggests social control measures to obtain ideal output
or optimum welfare. According to him, national benefit would be more if the value of social net
product is equal to the every possible experiment. If the price of social net product of factor is
less than a practice to the other then the national income benefits can be increased by transferring
the factors. This is possible only by social control. For example, the government can provide
adequate facilities to factory emitting smoke and then ask the factory owner to move the factory
out of the residential area. By doing so, the differences in social and personal costs and benefits
produced from the smoked nuisance are free from state interference. Regarding consumption
diseconomies, the state, by restricting the use of loudspeakers for important events, can stop
the noise. In monopoly situation, Pigou was in favour of any types of nationalization or social
control.
2. Taxes and subsidies: Apart from this to end the differences between social and personal cost and
benefits, Pigou suggests the use of taxes and subsidies. According to him, the state can impose
taxes on external diseconomies of production and consumption. For example, the government can
impose taxes on each family and then provide the collected amount to the factory owner to make
him move out of the residential area. In the condition of external diseconomies of production,
by providing financial assistance to the state consumers, the national benefits can be increased
so as to achieve an ideal production. By providing tax relief to consumers, the government can
increase the consumption ability of the consumers and thus helps in maximizing their desires.
This is described by the curves of demand and supply. A demand and supply curve of a
complete competitive market can only describe the visible personal benefits and cost but not the
externalities. Externality exists if the full competitive market will not provide a socially optimal
level. The government by imposing taxes and paying subsidies can internalize the externalities.
Assume that social benefits are more than personal benefits which indicate negative externalities.
In such cases, there is over-production of commodities that are required in society. To minimize
this Pigou suggested imposing taxes on commodities. This is shown in Fig. 24.1 where D and S
are, respectively, demand and supply curves. They intersect at E point and produces OQ. Curve
S includes the cost of the commodities used by the consumers. This does not include negative
externalities. When market supply curve S becomes identifiable and internalized the supply
curve S is created. Now, curve D intersects curve S at point E and OQ production is fixed
1
1
1
1
which is less than OQ. This is the social limit of production. On imposing taxes on consumers’
commodities per unit T, the production of commodity will become less from OQ to OQ which
1
will decrease the negative outputs of OQ production. Thus, over production will be ended and
social and personal benefits will be equal.
When personal benefits are more than social benefits then these are positive externalities. In
such cases, there is less production of commodities, as required by society. To increase this,
Pigou has suggested providing per unit subsidy for the commodities of the consumers. This
is shown in Fig. 24.2 where D and S are, respectively market demand and supply curve. This

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