The supply curve and the demand curve for cigars are straight lines.Suppose the equilibrium quantity in the market for cigars is 1,000 per month when there is no tax.Then a tax of $0.50 per cigar is imposed.The effective price paid by buyers increases from $1.50 to $1.90 and the effective price received by sellers falls from $1.50 to $1.40.The government's tax revenue amounts to $475 per month.Which of the following statements is correct?
A)The demand for cigars is less elastic than the supply of cigars.
B)The tax causes a decrease in consumer surplus of $390 and a decrease in producer surplus of $97.50.
C)The deadweight loss of the tax is $12.50.
D)All of the above are correct.

Question

Quizplus · Accepted Answer

A) The tax incidence falls disproportionately on buyers since the effective price paid increased more than the effective price received. This implies that the demand for cigars is relatively more inelastic than the supply of cigars.
B) The decrease in consumer surplus is (1/2) x (1000-833) x (1.5-1.9) = -$390. 
The decrease in producer surplus is (1/2) x (1000-833) x (1.5-1.4) = -$97.5. 
Therefore, B is correct. 
C) The deadweight loss is the reduction in welfare due to the tax that is not captured as revenue by the government. It is the area of the triangle formed by the points where the new supply curve intersects the old demand curve and where the new demand curve intersects the old supply curve, minus the revenue collected ($475). 
The deadweight loss is (1/2) x (167) x (0.5) - 475 = -$12.5. Therefore, C is correct.

Thus, all of the statements are correct, and D is the final answer.

The Supply Curve and the Demand Curve for Cigars Are