Question

Suppose that the Market for Cigarette is facing the Demand function Q = 20 – 2P and Supply function Q = 10.5 + 0.5P: a) What is the effect on the Equilibrium Price and Quantity when Government imposes a 7% of tax as percent of equilibrium price on each unit of Cigarette produced? [5 marks] b) What is the price elasticity of demand at equilibrium after tax and comment on the answer? [5 marks]

Answer 1

a)

$$20-2p=10.5+0.5p$$

$$2.5p=9.5$$

$$p=3.8$$

$$p_t=1.07\times3.8=4.066$$

$$Q=11.868$$

b)

$$E=-2\times\frac{4.066}{11.868}=-0.68$$

Since the government introduces an additional tax to reduce the consumption of cigarettes, we see that this measure is effective.