See why a negative externality makes a market over-produce — and how a corrective tax restores efficiency.
Understand why negative externalities cause overproduction and how a corrective tax aligns private incentives with social welfare.
Start with no tax. Compare the free-market quantity to the socially-optimal quantity.
Before you act, predict what will happen. Why does the market produce more than the social optimum when it only sees the private cost? Then do it — did your prediction match what happened?
Demand, private vs. social cost, and deadweight loss
A free market trades where demand meets private cost — ignoring the external cost, so it over-produces. The social optimum is where demand meets social cost. The shaded triangle is the surplus lost to the externality; a tax equal to the external cost closes it.