Monopoly Power and the Optimal Control of External Costs

Abstract

The extensive literature on production externalities has paid too little attention to the importance of controlling external costs when the generators of the externality exercise monopoly power in the goods market. What is more, the relatively few studies of this subject, found in the specialist environmental economics journals, appear to have reached an impasse. They have concluded that there is no single Pigouvian tax instrument that can achieve a socially optimal (efficient) level of the external cost, even if problems of information cost to the regulatory agency are ignored. In addition, the particular tax instrument that has previously been advocated will, in certain circumstances, involve the subsidization of the monopolist's efforts to reduce the external cost, while generating no revenue to finance the subsidy.