A country that does not tax cigarettes is considering the introduction of a $0.4

Question

A country that does not tax cigarettes is considering the introduction of a $0.40 per pack tax. The economic advisors to the country estimate the supply and demand curves for cigarettes as: QD = 140,000 - 25,000P; QS = 20,000 + 75,000P, where Q = daily sales in packs of cigarettes, and P = price per pack. The country has hired you to provide the following information regarding the cigarette market and the proposed tax.

b.   What price and quantity would prevail after the imposition of the tax? What portion of the tax would be borne by buyers and sellers respectively?

c.   Calculate the deadweight loss from the tax. Could the tax be justified despite the deadweight loss? What tax revenue will be generated?

Explanation / Answer

From the given data we know that the equilibrium in the market for cigarets is as follows:

140,000-25000P = 200000+75000P

=140000-200000=100P

=60000=100P therefore P=$0.6

Then we can derive the equilibrium quantity:

140000-25000(0.6) = 200000+75000(0.6)

= 140-15000= 200+45000

Q= 245000-125000 = 120000

To know how much of the tax is absorbed by the customers, we have to calculate the Elasticity of demand for cigarettes.

                                                      Change in P                      0.40

E is defined as                       -------------------------- = -----------------   = 0.0000034

                                                        Change in Q                   115

The elasticity of Cigarettes is ZERO

The tax of $0.4 will be fully absorbed ny the consumer.

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