Moving beyond perfect competition in teaching Pigovian taxation to control negative externalities: Some graphical analyses to illustrate the importance of market structure

The standard approach to teaching Pigovian taxation as a policy option to correct for negative externalities, like air or water pollution, is to illustrate it in a graphical model of perfect competition and then move on. This article brings together a somewhat fragmented literature, along with some fresh and expanded analysis, into graphs that can be used to teach undergraduate students the importance of market structure in applying Pigovian policy. With the use of such graphs, instructors can challenge students’ critical thinking skills in simultaneously dealing with two opposing sources of market inefficiency, in which monopoly power leads to an underproduction of output while a negative externality leads to an overproduction of output than is socially optimal.