The market for cigarettes has the following supply and demand functions:
= 8 + 3P
= 20 ―P
where P and P denote the prices (in pounds) received by sellers and price paid by buyers
respectively, and and denote the quantities supplied and demanded respectively. Similarly,
the market for potato crisps has the following supply and demand functions:
= 20 + P
= 40 ―P
(a) The government is considering levying a per unit tax of £1 on cigarettes. Calculate how this tax
will affect the quantity and price in the market for cigarettes. [5 marks]
(b) Suppose that the government were to instead levy a £1 per unit tax on potato crisps. How
much revenue would this tax generate? [5 marks]
(c) Suppose the government wants to raise £1 in tax revenue, and wants to do so by levying a per-
unit taxes on either cigarettes or crisps (but not both), in such a way that the excess burden of
taxation is minimized. Given this objective, which of the two commodities should be taxed?
Calculate and compare the excess burden associated with the tax on each of the two commodities
to justify your answer. [10 marks]
