Suppose that the demand for and supply of cigarettes in a hypothetical country a
ID: 1153728 • Letter: S
Question
Suppose that the demand for and supply of cigarettes in a hypothetical country are given by the following equations: Qd 2000 200P Q 200P, where Q is the number of packs of cigarettes and P is the price per pack of cigarettes a) Find the price and quantity of cigarettes, assuming the market is competitive. (2 marks) b) In an effort to reduce smoking, the government levies a tax of $2 per pack. Compute the 1. quantity of cigarettes after the tax, the price paid by consumers, and the price received by producers. How much revenue does the tax raise for the government? How much revenue comes from consumers, and how much from producers? (3 marks)Explanation / Answer
(a) In competitive equilibrium, Qd = Qs
2000 - 200P = 200P
400P = 2000
P = $5
Q = 200 x 5 = 1000
(b) The $2 tax will lower effective price received by sellers by $2, so supply will fall and supply curve will shift leftward by $2 per output at every output level. New supply function becomes
Qs = 200(P - 2) = 200P - 400
Equating Qd with new Qs,
2000 - 200P = 200P - 400
400P = 2400
P = $6 (Price paid by consumers)
Price received by producers = $6 - $2 = $4
Quantity = 2000 - (200 x 6) = 2000 - 1200 = 800
Tax revenue = $2 x 800 = $1600
Revenue from consumers = $(6 - 5) x 800 = $1 x 800 = $800
Revenue from producers = $(5 - 4) x 800 = $1 x 800 = $800
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