Micro Foundations · intermediate
What moves on the Externalities & Pigouvian Taxes diagram
Lower demand reduces market quantity and therefore total external damage, but leaves the marginal external cost wedge and the allocative inefficiency intact.
The overproduction problem is measured at the market quantity, where demand meets private supply.
A recession cuts demand for the polluting good at every price.
Market quantity falls, and so does total pollution, without any environmental policy at all.
But note what did not happen: the wedge between private and social cost is unchanged, so the market is still misallocating at the margin.
Examiners ask this as: demand falls, recession, less output, less pollution, emissions fall.
Other scenarios on Externalities & Pigouvian Taxes