Question

Secondhand cigarette smoke is believed to have a negative effect on the health of those who inhale it. These people have chosen not to smoke, but nevertheless are negatively affected by the choice of others to smoke.

a) Draw the market for cigarettes showing the demand, the marginal cost, and the marginal social cost of smoking cigarettes if this belief is correct.

b) Label the market price and quantity of cigarettes

c) Label the efficient quantity (the quantity that reflects private and public costs) of cigarettes. Explain your answer.

d) Demonstrate graphically the tax the government would have to impose on cigarettes to arrive at the efficient level and price of cigarettes and the revenue the government would collect from the tax. This tax would work like the other excise taxes that have been assessed on goods.

e) What would be the advantage to society of imposing this tax?

f) What would be the difficulty in imposing this tax?

Answer 1

(a)

Negative consumption externality shifts PMB curve leftward to SMB. Graph as follows.

(b)

Market outcome is at point A where PMB intersects PMC with market price P0 and output Q0.

(c)

Efficient outcome is at point B where SMB intersects PMC with efficient price P1 and output Q1.

(d)

The unit tax to internalize the externality is vertical distance AD per unit.

(e)

Advantage to society is the area of triangle ABC.

(f)

Imposition of tax may be difficult since it is difficult to precisely measure the per-unit external cost in consumption associated with the negative externality of smoking.