Smoking at Ike's Bar-B-Q Pit

As of 2019 two-thirds of the population of the United States, about 200 million people, lived in areas that had passed smoke-free laws for their restaurants and bars. Ike's Bar-B-Q Pit is located in an area that still allows patrons and bars and restaurants to smoke. Some of Ike's nonsmoking customers, including some who suffer from asthma, have asked Ike to adopt a no-smoking rule for his restaurant. But some of Ike's other customers complained that they have smoked in the restaurant for years and would no longer patronize his Bar-B-Q Pit if the no-smoking rule were adopted. Ike is worried because he does not wish to lose business from either his smoking or nonsmoking customers.

Draw a graph illustrating the externality associated with smoking in Ike's Bar-B-Q Pit and explain how this externality causes a deviation from economic efficiency in this market. Hint: Tobacco smoke is a negative externality and imposes negative costs on nonsmokers.

Step 2: Draw a graph to illustrate the externality at Ike's Bar-B-Q Pit.

This is a negative externality because there are external costs imposed on Ike's nonsmoking customers as a result of breathing second-hand smoke. These are costs that neither Ike nor his smoking customers have to pay.

Step 3: Describe how the externality causes a deviation from economic efficiency.

The economically efficient outcome is for the quantity of meals served at Ike's restaurant to be Q₂ and the price of the meals to be P₂. (Ike's has a varied menu with different meals with different prices. To simplify this problem, assume P₂ is an average meal price.) This outcome would be economically efficient because it is where the market supply curve that represents social costs, including the negative health effects on nonsmokers, crosses the demand curve. At this point, the marginal benefit from Ike's meals would equal the marginal social cost. However, because neither Ike nor his smoking patrons have to pay for the negative externality, the market supply curve represents only private costs. As a result, the equilibrium market price and quantity are P₁ and Q₁; the marginal social cost from Ike's meals exceeds the marginal benefit.