Question
Consider the following perfectly competitive market for cigarettes.The supply function is given by Q S = 4P and the demand function is given by Q
Consider the following perfectly competitive market for cigarettes.The supply function is given by QS= 4P and the demand function is given by QD= 10 - P.
a.Graph supply and demand in this market.Label each curve, each axis, and all intercepts.
b.Find the market equilibrium price and quantity.Label these on your graph.
c.Calculate the price elasticity of supply and demand at the equilibrium price and quantity
d. Now suppose the consumption of cigarettes creates a negative externality in the form of second-hand smoke.
i. Given this information, write an expression for the social marginal cost associated with the cigarette market, as a function of Q.
ii. Solve for the socially optimal quantity of cigarettes.
iii. What is the deadweight loss associated with the competitive market outcome?
iv. Qualify this deadweight loss explain intuitively why DWL results when the market participants act solely based on their own incentives.
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