The demand for cigarettes is given by P = 400 -0.2Q. Cigarettes are manufactured at a constant marginal cost of 50 and sold in a competitive market. What is the quantity of cigarettes sold in equilibrium? QPrivate = 1750 If cigarettes generate a marginal external cost of MEC = 0.05Q, what is the socially optimal level of cigarettes? QSocially optimal 500- 450- 400- 350- 300- 250- 200- 150- 100- 50- Price 400 Figure 1 800 1200 Output 1600 D 2000 Q

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Market Failure Analysis

To understand Market failure, we need to first understand welfare economics. An Italian economist, Vilfredo Pareto stated that allocation of resources in an efficient manner such that an economic change, which harms no one and makes someone better off, indicates an increase in social welfare. It is also called Pareto Optimality, where resources cannot further be reallocated without harming one. This does not apply to those economic changes, which harm some and benefit others. social welfare increases if the utility of any of its members' increases and none decrease in the economy.