Analyzing tax incidence

Problem 1. Draw the market demand and market supply in the market of cigarettes.

(a) What group is more sensitive to price changes, buyers or sellers?

(b) Show what happens in this market if the Government taxes the producers of cigarettes.

(c) Who do you think ends up bearing a higher portion of the tax?

(d) How would your answers change by the introduction of vaping pens not subject to the same tax?

Problem 2. Welfare Economics. Consider the market shown in Figure 1. (attached graph)

1. Assume the economy reached the competitive equilibrium, with equilibrium quantity Q* and equilibrium price

P*Identify the following areas in the figure

(a) Consumer surplus.

(b) Producer Surplus.

(c) Value to buyers of consuming Q* units.

(d) Cost to sellers of producing Q* units.

(e) Total surplus.

2. Now assume there is a benevolent social planner interested in maximizing total surplus. The planner is

considering increasing quantity from Q*

to Q¹ so that more consumers receive the benefit of consuming the

good.

(a) Identify the area corresponding to the cost of producing the additional Q¹ Q* units.

(b) Identify the area corresponding to the value to buyers of consuming the additional Q¹ Q* units.

(c) Is the idea of increasing the quantity from Q*

to Q¹ a good idea from the point of view of market

efficiency?

Consider the market shown in Figure 1. Figure 1: Market Equilibrium Price (P) Quantity (Q)