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Question

Difficulty: MediumEnvironmental Degradation, Issues, and Resource Management

In Nigeria's crude oil extraction sector, gas flaring generates severe negative externalities, such as environmental degradation and public health hazards in host communities. Which economic policy instrument directly internalizes this negative externality by forcing petroleum firms to incorporate the social cost into their private cost of production?

  1. Levying a Pigouvian pollution tax equal to the marginal external costAnswer
  2. B
    Providing production subsidies to oil extraction companies to increase output
  3. C
    Commercializing state-owned enterprise equity without environmental regulation
  4. D
    Imposing a maximum price ceiling on refined petroleum products in domestic markets

Answer

Levying a Pigouvian pollution tax equal to the marginal external cost
Levying a Pigouvian tax directly forces polluting firms to pay for the spillover environmental damage they cause. This shifts the private supply curve upward so that marginal private cost equals marginal social cost, thereby internalizing the externality and reducing environmental degradation.

Step-by-Step Solution

1
Identify the economic nature of gas flaring
Gas flaring represents a negative production externality where Marginal Social Cost exceeds Marginal Private Cost.
Third parties (local communities) bear environmental and health damage costs that oil firms do not include in their market prices.
2
Evaluate environmental economic policy tools for internalizing spillover costs
A tax on pollution raises private production costs to match social costs.
By taxing each unit of pollutant equal to the marginal damage, firms are incentivized to reduce pollution to the socially optimal level.

Key Concept

Internalization of Negative Externalities in Resource Management
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Topics

Environmental Degradation, Issues, and Resource Management