Question

Assume the market for cigarettes is perfectly competitive. The demand and supply for cigarettes in Oakland is given by the following equations:

Where P represents the price of a carton of cigarettes and Q denotes the quantity of cartons of cigarettes. Use the above information to answer the following questions. Show your work for full credit.

a. Draw a graph of the market in equilibrium and solve for the equilibrium quantity and price. Identify on your graph and calculate the values of consumer, producer, and total surplus. Be sure to label your graph.

P* = _________ Q* = _________ CS = ___________ PS = ___________ TS = ___________

b. Suppose a panel of public health scientists from the Food and Drug Administration (FDA) determine that half a unit of air pollution is emitted for every carton of cigarettes that is smoked and that the external cost (that is the cost that people outside of the market bear) of one unit of pollution is $100. What is total external cost of the air pollution given the market equilibrium quantity of cigarettes exchanged in the unregulated market from part (a)? How does this alter your calculation of total surplus once the external cost is taken into account?

Total External Cost = ___________ TS given External Cost = ___________

c. Now consider a potential FDA regulation to address this air pollution that bans the production and sale of cigarettes. What is total surplus if this policy is imposed? Are the consumers or producers of cigarettes hurt the most by the ban? Support your answer with at most two sentences.

Total Surplus with the ban = ___________ Who is hurt most from the ban? ___________

d. Another potential FDA policy would be to place a lump sum tax the sale of cartons of cigarettes rather than ban cigarette sales as in part (c). The following equation gives the demand curve including the impact of the tax:

Draw a new graph that illustrates the impact of the tax and find the after-tax quantity and the prices paid by buyers and sellers. What is consumer surplus, producer surplus, tax revenue, DWL, and the external cost after the tax is imposed. From your analysis, can you determine who pays the tax directly to the government?

Pbuyer = _________ Pseller = _________ Qtax = _________ CS = _________ PS = _________ Tax Revenue = _________ DWL = _________ External Cost = _________ Who pays the tax to the government? _____________________________

e. Imagine you were the head of the FDA and you must decide whether the FDA should intervene in this market and, if so, in which way to intervene. Would you intervene and, if so, which of the above policies would you choose (the ban or the tax)? Support your answer with no more than two sentences.

Answer 1

A) equilibrium,

-2p+380=3p-60

440=5p

P=440/5=88

Q=3*88-60=204

CS=1/2*204*(190-88)=102*102=10,404

PS=1/2*204*(88-20)=102*68=6936

TS=10,404+6936=17,340

B) Total pollution=204/2=102

Total external cost=102*100=10,200

TS=17,340-10,200=7140

C)If Production and sales of cigs gets ban ,then it means there will no Quantity sold and the total surplus will be zero.

Because loss of CONSUMER surplus is 10,404, while loss of producer surplus is 6936.

So CONSUMER loss is higher.

D)new equilibrium,

320-2p=3p-60

380=5p

P*=380/5=76

Q*=320-2*76=168

Price buyer pay=190-0.5*168=106

Price produer get=76

Tax{ per unit}=106-76=30

CS=1/2*168*(160-76)=84*84=7056

PS=1/2*168*(76-20)=84*56=4704

Tax revenue=30*168=5040

Optimal tax should be =50

And in that case,

Qd=280-2p

Equilibrium,

280-2p=3p-60

P=340/5=68

Q=3*68-60=144

Deadweight loss=1/2*(50-30)*(168-144)=10*24=240

External cost=168*50=8400

CONSUMERs pay the tax.

E) In case of ban of Production and sales ,the net benefit to society was zero.

In case of 30$ per unit tax ,the net benefit to society=CS+PS- DWL=7056+4704-240=11,520

So net benefit or surplus to society with tax policy is positive and very high compare to complete ban .

So I would choose tax policy.