Supply in the market for cigarettes is perfectly competitive,given by the function Q_S = P. True demand in the market is Q_D = 100 - P. Due to behavioral biases (of whatever form,whether people have limited willpower or have limited cognitive abilities to process the actual health effects of smoking),people overestimate the value of cigarettes,leading to the perceived demand curve $Q _ { D } = 200 - P$ .Compute the deadweight loss from the overconsumption generated by this behavioral bias. (Hint: use the perceived demand curve to compute market equilibrium but make your welfare calculations using the true demand curve.)

Question

Quizplus · Accepted Answer

Using the perceived demand curve Q_D=200−P, we can find the market equilibrium by setting this equal to the supply curve: 200 - P = P Solving for P, we get P=100. However, we need to use the true demand curve to calculate welfare effects. At the market equilibrium of P=100, the quantity demanded according to the true demand curve is: Q = 100 - P = 100 - 100 = 0 The quantity supplied at this price is: Q = P = 100 Therefore, there is a deadweight loss of Q = 0 due to the overconsumption generated by the behavioral bias. The deadweight loss is equal to the difference between the quantity transacted in the market under the true demand curve and the socially optimal quantity, which is zero in this case. Alternatively, we can calculate this as the area of the triangle formed by the difference between the true demand curve and the supply curve, with a height of 100 and a base of 100. Area of triangle = 1/2 * base * height = 1/2 * 100 * 100 = 5,000 Dividing this by 2 (since there are two identical triangles formed by the difference), we get a deadweight loss of 2,500. Therefore, the answer is D) DWL = 2,500.

Supply in the Market for Cigarettes Is Perfectly Competitive,given by the Function