Explain why it is not necessary to tax or subsidize victims

Explain why it is not necessary to tax or subsidize victims of pollution to induce them to undertake the optimal level of preventative activity.

Solution

Pollution is a negative externality to society which is not undertaken by private producers in the market. In free market equilibrium quantity that is produced is higher than quantity that maximises social welfare. This is because private cost of producing the good that emits pollution is lower than social cost of producing the good.

In case of negative externality, quantity produced is not socially optimal quantity. Thus to get the social optimal quantity produced, government needs to subsidise victims or tax the producers.