Welfare implications of Pigovian taxation of a durable goods monopolist

Abstract

This paper examines the effectiveness of Pigovian taxation in checking the behaviour of a durable goods monopolist who generates some externality in the production process. The durable good lasts two periods. It is found that while the effect of an increase in the tax is to lower the first period output, the second period output decreases only under certain conditions. The overall welfare effect of a Pigovian tax can either be positive or negative depending on the relative magnitudes of the price-cost margins, the extent of the negative externality, the extent of longevity (durability) of the first period output and the underproduction relative to social optima. Public policy implications are discussed.