2 Q2 [extra Quality]: Hkcee 2010 Econ Paper

To correct the market failure, the government could impose a Pigovian tax equal to the marginal external cost per unit. This raises the firm’s marginal private cost to MSC, internalizing the externality and restoring the social optimum. The tax is economically efficient and raises public revenue but requires accurate estimation of the external cost and effective enforcement; misestimation leads to inefficiency. Alternatively, the government can set emission standards or limits (regulation). Standards guarantee pollution reduction but can be less cost-effective because firms face different marginal abatement costs. Tradable permits (cap-and-trade) combine certainty about total emissions with cost-effectiveness: firms with low abatement costs sell permits to high-cost firms. Downsides include administrative complexity, initial permit allocation issues, and the need for robust monitoring.

This is a classic "trap" question. Students often confuse "opportunity cost" with "net benefit." While the hkcee 2010 econ paper 2 q2