Governor Jerry Brown is about to propose his an initiative to
pay for losses sustained in the Southern California wild fires by
imposing a cigarette tax on all cigarette sales in the State of
California. Specifically, he asks you to estimate the annual
deadweight loss of the tax. You are told the following: the tax is
25 cents a pack; the uncompensated elasticity of demand for
cigarettes is -0.5; the elasticity of supply of cigarettes is 0.75;
and, in the absence of this tax, the price of cigarettes is $5.89 a
pack and 2.6 billion packs are sold annually.
a. Calculate and report an estimate of the annual
deadweight loss of the tax.
b. Is your estimate an accurate measure? Why or why not? If you
believe it to be inaccurate, is it an underestimate or an
overestimate of the true excess burden? Be sure to buttress your
answers with economic reasoning.