Econ Assessment - Assignment Example

Name: Tutor: Title: Assignment questions Institution: Date: Question one a) Panic buying results into increase in price and decrease in sales of cigarettes. It is believed that supply of cigarettes is price elastic while their demand is price inelastic. Therefore, with panic buying of tobacco, suppliers will hoard cigarettes for fear of high production costs in future, thus reducing supply or sales of cigarettes in the market. The artificial cigarette shortage created in the market will increase cigarette prices. The effect of panic buying can be illustrated diagrammatically as follows. The above graph shows equilibrium price and quantity of cigarettes before the effect of panic buying. The demand curve is price inelastic, that is, changes in price results in a small change in quantity demanded. The supply curve on the other hand is price elastic, that is, change in price results in proportionate change in quantity supplied. Panic buying reduces supply of cigarettes, thus shifting supply curve inwards, from S to S1 as shown below. From the graph, the shift in supply curve sets new equilibrium at E1, price on the other hand increases from P to P3 and quantity reduces from q to q1. Therefore, panic buying increases price of cigarettes to P1 and decreases sales to q1. b) Crackdown on internet advertising of cigarette reduces price and sales of cigarettes. It is believed that crackdown on internet advertising of cigarette is a strategy designed at decreasing the amount of cigarette demanded at any given price. The effect of internet advertisement restrictions on sales and price of cigarettes can be illustrated as follows. From the above graph, restriction on internet advertisement causes the demand curve to shift from D to D1, thus changing equilibrium price and quantity. The inward shift of the demand curve reduces equilibrium price to P1 and equilibrium quantity to q1. Sales or supply of cigarettes decreases from q to q1. Therefore, crackdown on internet advertisement reduces price and sales of cigarettes. Question two a) The burden of new tax will be borne more by consumers. Inelastic demand and elastic supply are some of the features that define cigarette industry. Elasticity and tax burden go hand in hand, that is, if supply is elastic and demand elastic, the tax burden will fall on producers. Alternatively, if supply is elastic and demand inelastic, the tax burden will fall on consumers. Therefore, in cigarette industry, the burden of new tax will fall on consumers as illustrated in the diagrams below. Introduction of new tax causes supply curve to shift inwards as shown in the above diagrams. The inward shift increases equilibrium price to P2 and reduces equilibrium quantity to q2. The shaded regions P1P2 and P3P1 represent the tax burden paid by consumers and producers respectively. In the first diagram, where demand is elastic and supply elastic, the tax burden paid by consumers is very small as compared to tax burden paid by producers. In this scenario, the tax burden is borne more by producers. The second diagram illustrates cigarette industry, which has inelastic demand and elastic supply. The tax burden falls largely on consumers. In cigarette industry, producers do always shift the tax burden to consumers since they know smokers are price insensitive. Smokers are always ready to buy cigarettes at any price. Producers can easily shift the tax burden to consumers through price increase. This is illustrated in the second diagram by a big change in prices. The burden of tax paid by consumers is greater than the tax burden paid by producers. Therefore, as illustrated in the second diagram, the new tax on cigarette will be borne more by consumers. Question three a) In the face of price increase, people from low income groups are more likely to quit smoking than those from high income brackets. Individuals from low income groups are more responsive to changes in price of cigarettes than those from high income groups. Low income earners are always price sensitive. A small increase in cigarette price will make low income earners avoid buying the product, thus making them quit smoking. High income groups on the other hand are insensitive to price changes. An increase in cigarette price will not affect their smoking habit. High income earners will continue smoking since the price increase will not affect their acquisition of basic necessities. b) The possibility of low income groups quitting smoking will be lower in the long run. It is believed that, in the short run, low income earners do always quit smoking due to budget constraints. However, in the long run, they will find alternative ways of supplementing their income and resume smoking. This therefore, lowers the probability of low income groups quitting smoking. Question four a) If the cigarette industry is perfectly competitive and cigarettes are identical, it implies that cigarette prices are determined by interaction of demand and supply. Therefore, cigarette producers and consumers are price takers, as shown below The market demand curve is downward sloping while the demand curve for individual cigarette producer is a horizontal line. The equilibrium price is determined by the market. An introduction of government anti-smoking campaign affects the market demand curve. Therefore, if the government anti-smoking campaign proves to be successful, the market demand curve will shift inwards, thus lowering equilibrium price. Regardless of cost incurred, individual cigarette producer will have to sell its cigarettes at price set by the market. In the short run, a firm in a perfectly competitive market can only maximize profit at a point where price equals marginal cost as shown. The shaded part in the above diagram shows the total amount of profit a profit-maximizing firm can attain. A firm makes profit at a point where price (P) is greater than average total cost (ATC). It incurs losses at P Read More