Question

There are two estimates for the price elasticity of demand for cigarettes, one is -0.4 and the other is -0.8. Assume that the government decides to increase cigarette taxes, which leads to a 20% increase in cigarette prices. You are hired as a consultant to use your economics expertise to predict the impact of this tax change. Use the given information to answer the following questions.

a. One of the elasticity figures refers to short-run and the other to long-run. Briefly explain which estimate corresponds to which case and why.

b. In each case (i.e. short-run and long-run), by how much will the quantity demanded for cigarettes change? Show your calculations.

c. Based on your answer to part b above, briefly explain whether the tax hike worked best in the shortrun or the long-run, if the aim was to reduce negative consequences of smoking?

d. If e-cigarettes are more addictive compared to regular cigarettes, would you expect the demand for ecigarettes to be relatively more or less price elastic compared to the demand for regular cigarettes? Explain briefly.

Answer 1

a) In the long run the goods are more elastic as we have more substitute for the goods. The elasticity of -0.8 is in the long run and -0.4 is in the short run. In the short run, the goods tend to be more inelastic.

b) IN the short run the demand will change by -0.4 = (x) / 20%

= (x) = -0.4 x 20%

(x) = 8%, the demand for the goods in the short run will change by 8% when the tax increase by 20%.

In the long run, the demand will change by -0.8 = (x) / 20%

= (x) = 16%. in the long run the demand will decrease by 16%.

c) As the reduction in the demand is more in the long run, we can say that the tax hike worked more in the long run. IN the long run the demand was reduced by 16% that is twice the number of the short run.

d) As the E cigarettes are more addictive than the regular cigarettes then the demand for these cigarettes will be more inelastic i.e. if the price of these cigarettes increased the demand will not fall as much as the price has increased. As the people using them wil not be able to quit easily even if the price rise.