Specifically when there is the presence of a "Negative Externality"---a cost that occurs in the production and consumption of a good that is not included in the production and consumption of that good--but it imposes some harm on those not involved in the transaction.
Secondhand smoke from cigarettes is a good example. When cigarettes are produced and consumed only the market price of the inputs are included in the price---not the costs that they might impose on the rest of us.
Plastic bags you see in grocery stores is another example. It is suggested that these bags impose significant damage to the environment in a number of ways. And, heck, we get them "free" at the store.
This additional cost that is NOT borne by the producer or consumer of the good is called an "external cost". How can we capture this external cost and compel it to be "internalized" by the parties who care the most---the producers and/or consumers?
"""Last year shoppers in the UK used an astonishing 8.4 billion plastic bags. Per person this means a plastic bag is used and disposed of every three days.
Plastics have harmful effects and ecologists have singled out plastic bags as being particularly troublesome as they blow in the wind and can spread to remote environments. Governments are therefore trying to tackle plastic bag usage.
In 2002 Ireland became the first country to introduce a plastic bag levy and UK countries have followed suit with Wales (October, 2011), Northern Ireland (April, 2013) and Scotland (October, 2014) implementing their own charges. Today a plastic bag levy for England has come into effect.
The results of the plastic bag levies across UK countries, all starting from a similar point, are staggeringly successful. A 5p levy has seen plastic bag usage drop 78% in Wales and 80% in Northern Ireland while preliminary data from Scotland shows a remarkably similar 80% fall in use. The result also looks quite good, with marine litter surveys showing large declines in plastic bags."""One way to internalize the cost is a tax by the government. This will raise the price of the good and if our Laws of Demand and Supply are correct (even half-way so) then we should see a reduction in production and consumption. At the minimum we compel the users of the good to bear the "true cost".
I put this to the test in a series of graphs and explanations. Look them over and I welcome any comments or constructive criticism.
Hope it helps. Thanks!