Question
5. Assuming the market for cigarettes is characterized by an inelastic downward-sloping demand curve and an elastic upward-sloping supply curve. (a) In your own choice
5. Assuming the market for cigarettes is characterized by an inelastic downward-sloping demand curve and an elastic upward-sloping supply curve. (a) In your own choice of words and understanding, what is deadweight loss? (b) Draw the competitive market equilibrium. Label the price, quantity, consumer surplus and producer surplus. Is there any deadweight loss? Explain. (c) Suppose the government charges a value added tax on each packet of cigarettes sold. Illustrate the effect of this tax on the cigarette market. Ensure you label the consumer surplus, producer surplus, government revenue and deadweight loss. How does each area compare to the pre-tax case? (d) Who bears the larger portion of the tax burden, consumers or producers? Explain (e) If the tax were removed, tobacco smokers and producers would be better-off, but the government would lose tax revenue. Suppose that consumers and producers voluntarily transferred some of their gains to the government. Could all parties (including the government) be better off than they were with tax? Explain using the labeled areas in your graph.
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