Question 2

Consider the cigarettes market in an economy. The demand for cigarettes is given by the equation P = 20 – 0.2Q and the supply of cigarettes is given by the equation P = 5 + 0.1Q, where P is the price per packet in dollars and Q is the number of packets of cigarettes.
(a) Assume that the cigarettes market is perfectly competitive. Solve for the market equilibrium price and quantity of cigarettes. Compute the producer surplus and the consumer surplus in the cigarettes market. Use a well-labelled graph to illustrate all of the characteristics of the competitive market equilibrium you have solved for.  (10 marks)
(b) To discourage cigarettes consumption, the government imposes a tax of $3 per packet on the suppliers of cigarettes. Calculate the new market equilibrium quantity, the amount of tax revenue collected, the consumer surplus and the producer surplus after the tax is imposed. Determine the deadweight loss caused by the tax. Use one (1) well-labelled graph to illustrate the market outcome, before and after the tax. (12 marks)
(c) Under what supply and demand conditions can a tax be imposed without causing deadweight loss? Explain and justify your answers with suitable diagrams.  (8 marks)