Assume that the daily demand for packs of cigarettes in a fictitious country is given by the demand function Q = 50 – P. The marginal cost of producing a pack of cigarettes is $5 and the market is perfectly competitive. Also assume that each pack of cigarettes smoked does $5 worth of health damage to the smoker’s neighbors by exposing them to secondhand smoke.

1. Draw the private supply curve and the private demand curve in this market. You can use the graph provided at the end of the assignment. What is the privately efficient quantity of packs purchased per day?
2. Draw the public supply curve in this market. Explain why it differs from the private supply curve, and how this represents the externality from secondhand smoke. Highlight the area of your diagram that represents social loss and interpret this loss in terms of cigarette smoking.
3. Suppose that due to the introduction of new tobacco fertilizer, the cost of producing a pack of cigarettes drops from $5 to $1. How does this affect the level of smoking and the level of social loss? Explain your answer.
4. Suppose the government decides to pursue a Pigouvian solution to eliminate social loss. What sort of tax or subsidy would they implement, and what is the resulting quantity of cigarette packs purchased?
5. The parliament of this fictitious county loudly opposed the proposed tax/subsidy plan as government meddling and pass a new law giving anyone the right to forbid their neighbor from smoking. Who benefits and who is harmed by this new law? How will this affect the level of smoking?