Question

Suppose that cigarette consumption poses a negative externality on society. a. Draw a graph and use the graph to help explain the impact of this negative externality on social welfare. Is the cigarette market efficient? Why or why not? b. Show graphically and explain how a per unit tax could be placed on cigarettes in order to solve the negative externality.

Answer 1

If negative externalities are produced when smoking it means marginal social benefits are less than marginal private benefits.In the case of smoking the consumers will not think about the effect of passive smoking on society but only their cost and benefit. The market for smoking has three different market failures and therefore calls for government intervention and market inefficiency.Firstly there is information failure about health risk. Secondly there is information failure about addictive potential of tobacco and thirdly the market failure is the external cost of smoking that is the harm caused to others by smoking.Per unit tax on cigarette will raise the price and reduce consumption.