Question one

(a) Use diagrams to discuss and explain market failure and how social optimality can be restored, in a market where the market fails to ensure optimality.

b) Discus the three criteria used in welfare economics to decide whether a policy will make society better off?

Question two

Suppose that medical research studies have established that charred meat grilled over hot coals causes cancer. Since the government cannot easily regulate home cooking methods, it decides to place 4 taxes per unit at the retail level on charcoal to discourage the consumption of barbecued meat. Suppose that daily demand for charcoal is P = 120 - 2Q and supply is P = 30 + Q , where P is dollars per bag and Q is the number of 10kg bags of charcoal sold weekly.

(a) What are the before-tax price and quantities?

(b) What are after-tax price and quantities?

(c) How is the tax divided between sellers and buyers?

(d) Present your results in (a & b) on a diagram.

(e) If the supply curve is perfectly elastic and demand curve is downward sloping, what is the effect of a $1 specific tax collected from producers on equilibrium price and quantity, and what is the incidence on consumers? Why?