2.

(a) Suppose an ad valorem tax (equal to) is imposed on cigarettes. Assuming that supply is perfectly elastic, graphically identify the excess burden generated as a result of the tax. Define the excess burden of taxation. Does the excess burden of taxation increase, decrease, or remain constant as the tax rate increases? Explain.

(b) If the demand curve for cigarettes in part (a) can be expressed as and the equilibrium price and quantity before the tax are $4 and 100 respectively, calculate the excess burden of the tax if the tax rate is 6 percent. How does the excess burden of the tax you computed compare to the excess burden that would be generated under a lump-sum tax scheme? Explain.