Question

1) Elasticity of demand: The Czech government has raised the excise tax on tobacco products several times. Using price elasticity of demand, describe the potential impacts of this increase on the demand for cigarettes.   

2). Using graphs, explain how optimal price and quantity are set by perfect competitive firm in short time (in the case of maximization of profit).

Answer 1

1)

Elasticity of demand is dependent on the addiction of people. Generally as the people who consume cigarettes are habitual of it so there preference to consume it does not change much with the change in price.

As here the Czech government has raised the excise tax on tobacco products several times. This will cause price of the cigarettes to rise as a result there will be less proportionate change in quantity demand because price elasticity of demand for cigarettes are inelastic.

2)

In the graph below, Revenue and cost are on Y axis and Quantity is on X-axis. In perfect competition, firms are price taker so the firm faces a horizontal demand curve or price curve parallel to X axis. MC is U shape curve. Equilibrium (Point of profit maximization) arises at a point where MC=AR where equilibrium quantity is Q* and Price is P*.