Price Control and Tax Question Answer.doc

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Thompson Rivers University
ECON 1900
Nancy Carson

Answer to Price Control and Tax Question Supply and Demand in the cigarette market in the Republic of Dementia are shown in the diagram. The equilibrium price is $8 per unit and the equilibrium quantity is 40 million packs. Price ($/pack) 16 a) The Dementia Government is determined to reduce cigarette consumption to 30 million packs. Supply 14 One way of doing this would be to raise the price through the use of a price floor; and one way to 12 sustain the price floor would be to guarantee the cigarette manufacturers a higher price by offering 10 to purchase and destroy any excess cigarettes that demanders are not willing to buy at the higher 8 price. If this approach is adopted: 6 i.) What price floor is necessary to reduce cigarette consumption to 30 million packs? $10 4 ii.) How many packs of cigarettes would the government have to buy? 20 million 2 Demand iii.) How much money would the government be spending on cigarettes? $200 million 10 20 30 40 50 60 70 80 iii.) By how much would Dementia consumer’s Quantity of expenditure on cigarettes change, compared to the cigarettes initial equilibrium? It would Decrease (circle (millions of packs/year) one) by $ $20 million . Cigarette producers will like the price floor Price ($/pack) b) Some one has suggested that cigarette 16 consumption could be reduced by reducing the Supply price instead of increasing it. Suppose the 14 government likes this suggestion and therefore imposes a price ceiling as a method of reducing 12 cigarette consumption. Assuming that this price control is enforced successfully: 10 i.) At what level will the ceiling need to be set in order to reduce cigarette 8 consumption to 30 million packs? 6 $ 6 per unit ii.) With the price ceiling at this level, how much will Dementia consumers’ 4 total expenditure on cigarettes be? $ 6(30 million) = $180 million 2 Demand iii.) How much excess demand for cigarettes is there as a result of the price 10 20 30 40 50 60 70 80 ceiling? 20 million packs Quantity of
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