Question

3. Demand and supply of cigarettes in California are: Supply: Qs = 2Ps + 20 Demand: Qp = 200 - PD a. Calculate the market equilibrium price and quantity, assuming perfect competition. California decides to tax on cigarettes to fund preschool. It recognizes that a secondary benefit of the tax would be to reduce teen smoking. Suppose taxes of $15 per carton are placed on the consumption of cigarettes. By how much will the tax increase the price consumers pay? By how much will it decrease the price producers receive? How much revenue will this tax raise? By how much will it reduce smoking? Voters argue that it is unfair for poor and addicted cigarette consumers to pay the tax. They argue that instead the wealthy tobacco companies should pay the government the $15 tax. Would this make consumers better off as compared to the tax in (b)? Show this mathematically.

Answer 1

3.a. Equilibrium occurs where Demand equals supply.

2P+20=200-P

3P= 180

P=$60

Equilibrium Price P*= $60

Q= 2*60+20= 120+20=140

Equilibrium Quantity Q*=140

b. Tax on consumers= $15

New Demand Qd= 200-(P+15)= 185-P

New Equilibrium:

185-P=2P+20

165=3P

P=$55

New Equilibrium Price P**= $55

Price received by sellers= $55

Price paid by consumers= $55+tax= $55+$15= $70

Price paid by consumers rises by $10 as $70-$60=$10.

Price paid by sellers falls by $5 as $60-$55=$5

New Equilibrium Quantity= 185-55= 130

c. Tax revenue= Tax* Quantity= $15*130= $1950

Smoking reduces by 140-130= 10 cartons.

d. No, consumers will not be better off, as it doesn't matter on whom (seller or buyer) the tax is imposed. The incidence of tax remains the same.

Tax on sellers= $15

New supply= Qs'= 2(P-15)+20= 2P-30+20= 2P-10

New Equilibrium:

2P-10=200-P

3P= 210

P***= $70

Price paid by consumers= $70

Price received by sellers= $70-Tax= $70-$15=$55

So, the price paid by consumers and Price received by sellers

is the same as in (b). So the consumers will not be better off.