What is the largest problem associated with using a tax to ...

[cagreen833]

What is the largest problem associated with using a tax to correct for an externality? Explain.
 
  What will be an ideal response?

Question 2

Refer to Figure 19-4. The equilibrium exchange rate is originally at A, 3/pound. Suppose the British government pegs its currency at 4/pound.
 
  Speculators expect that the value of the pound will drop and this shifts the demand curve for pounds to D2. If the government abandons the peg, the equilibrium exchange rate would be
  A) 4/pound. B) 3/pound.
  C) 2/pound. D) less than 2/pound.

[apple]

Answer to Question 1

The biggest problem with using a tax to correct for an externality is that damages must be estimated in financial terms. This is quite difficult to do. If the tax is incorrect, the outcome will not be efficient. In fact, the tax could lead to an even greater amount of inefficiency.

Answer to Question 2

C