Question

Supply Social (Private costs + External costs Supply Internal (private Costs) Demand Internal 67 80 Quantity of packs of cigarettes measured in millions a. What is the equilibrium price and quantity if this is an unregulated market? b. What is the external cost? (Assume the external cost is the same along the the supply curve) c. What would be an appropriate solution for the government to mitigate this market failure? Be specific d. What would be the outcome of the government's action in terms of the new price and quantity of cigarettes? e. What is the deadweight loss when this market is unregulated?

Answer 1

a)

In case of unregulated market,

Look for the point where demand internal curve intersects the supply internal curve.

So, equilibrium price=$8

Equilibrium quantity=80 million packs

b)

External Cost is equal to vertical distance between supply internal curve and supply social curve.

So, External Cost=10-6=$4 per pack.

c)

Government should place a tax which is equal to external cost i.e. $4 per pack.

d)

In case of regulated market,

Look for the point where demand internal curve intersects the supply social curve.

So, equilibrium price=$10

Equilibrium quantity=67 million packs

e)

Dead weight loss=1/2*(10-6)*(80-67)=$26 million