Question

Government tries to discourage tobacco usage. In order to do that, they would like to set a higher price for tobacco. Currently, tobacco is priced $10 in the markets. Market research uncovered that the current price elasticity of tobacco is 0.3.

a. Given this information, what should be the new price set by the government so that tobacco consumption would fall by %25?

b. Do you think this policy will be more effective in the long-run? Support your answer with a graph. Show what you expect to happen to tobacco consumption in the long-run, compared to the short-run.

Answer 1

a) The elasticity of demand for tobaccos is the percentage change in the quantity demanded of tobaccor, due to unit percentage change in the price of tobacco.

Here, the elasticity of demand is 0.3, which means that for a unit price change in tobacco, the quantity demanded would decrease by 0.3 percent.

The percent of tobacco consumption must be decreased by 25 percent, the elascity of demand is given 0.3.

Thus the percentage change in price in price= Percentage change in quantity/ Elasticity of demand.

Percentage change in price= -25/ 0.3 = 83.34

Thus, the price of tobacco must rise by 83.34 percent to decrease the tobacco consumption by 25 percent.

Previous price was $10. The persent price must be= 10+(10*83.34%) = $18.334

b) The policy would seem to be less effective in the short run, as the tobacco consumers being addicted to tobacco cannot instantly reduce their tobacco consumption owing to the price prise. The quantity of tobacco consumption would be initially more or less same even after the price rise.

However, the policy would be effective in the long run, as the consmers would eventually bring about changes in their consumpton pattern, and being rational might not agree to spent much amount for tobacco consumption, this would make the policy effective in the long run, than in the short run.