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.