QUESTION 1

Suppose there is a bill to increase the tax on cigarettes by $1 per pack coupled with an income tax cut of $500. Suppose a person smokes an average of 500 packs of cigarettes per year-and would thus face a tax increase of about $500 per year from the cigarette tax at the person's current level of consumption. The income tax measure would increase the person's after-tax income by $500.

Would the combined measures be likely to have any effect on the person's consumption of cigarettes? Why or why not?

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QUESTION 2

Suppose a firm finds that the marginal product of capital is 60 and the marginal product of labor is 20. If the price of capital is $6 and the price of labor is $2.50, describe how the firm should adjust its mix of capital and labor? What will be the result?

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QUESTION 3

Please explain why the law of diminishing returns applies only in the short-term period.

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