Suppose the supply and demand schedules for cigarettes are as follow: What is th

Question

Suppose the supply and demand schedules for cigarettes are as follow: What is the equilibrium price? What is the equilibrium quantity? Now, the government levies a $1.25 per carton excise tax on cigarettes. What is the new equilibrium price paid by consumers? What is the new equilibrium price received by producers? What is the new equilibrium quantity? Explain why it makes no difference whether Congress levies the $1.25 tax on tire consumer or the producer? Suppose the tax is levied on the producers. How much of the tax are producers able to shift onto consumers? Explain how they manage to do so? Will there be any excess burden from this tax? Why? Who bears this excess burden?

Explanation / Answer

What is the equilibrium price? $4. What is the equilibrium quantity? 240 (Since the demand and the supply equate each other here) Now the government levies $1.25 excise tax on cigarattes per carton then The new equilibrium price paid by consumers will be $4.625 (4+0.625) Since the other factors remain the same The new equilibrium price received by the producers will be $3.375 (4-0.625) The new equilibrium quantity would be 240 It does not make a difference as to the congress levies the tax on the consumer or the producer since these kind of taxes are borne equally by both i.e the producer and the consumer. If the tax is levied on the producer then they pass a portion of the additional costs on the consumers in the form of higher prices. An important thing to consider here is that who pays the tax does not depend on whom the tax is levied. This kind of taxation is known as the tax incidence. This further depends on the elasticities of supply and demand. Incase the the price elasticity of demand is higher than the price elasticity of supply than the burden will fall mainly on the producer whereas if the price elasticity of supply is higher than the price elasticity of demand then it will all on the consumer.

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