Externalities

Microeconomics

Question 1

  • Externality in the market for sugar drinks

By defining externality as an intended effect of one sector of an economy to another, then there is no doubt that sugar sweetened drinks have got externality. Diabetes and obesity conditions are predicted by consumption of sugar sweetened drinks. These two condition costs the government a lot of resources in terms of health care. Such an effect is a negative consumption externality of the sugar sweetened drinks.

  • Effect of tax on equilibrium price and quantity of sugary drinks

Tax on sugary drinks will lead to an increase of price of these drinks. The supply curve will shift upward with the same magnitude as that of the tax, distorting the market equilibrium. As a result of increased market the demand of sugary drink will fall depending with the magnitude of the demand curve. Thus tax will increase price and reduce demand of sugary drinks.

  • Tax burden sharing

The demand function for sugary drinks elastic, however, the supply function is relatively more elastic than the demand function. Therefore, the consumers and the suppliers will share the burden but the consumer will bear larger tax burden compared to the supplier. This mainly because sugary drinks are a lifestyle drinks and thus a response of demand to price increase is low.

Question 2

A consumer major objective is to maximize utility subject to budget constraints; that is, get the maximum satisfaction out of the disposable income. It is apparent that resources are always scarce and wants are unlimited. To get the maximum utility; a consumer should organize his wants according to satisfaction he derives from each good. A consumer should consume a combination of goods that will give him maximum satisfaction. In so doing he will have maximized utility.

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