ABSTRACT
In a “first-best” world, it would be optimal to correct for an externality by imposing a correcting charge equal to the short-run marginal external cost or a Pigovian tax. The transportation sector shows how this simple idea can be complicated because the damage function is so complex. The global, regional, and local components of the damage, each has a different logic. In this chapter, I describe the damage function and discuss how it can be sufficiently simplified and stylized to serve as a starting point for the discussion of policy instruments.
