Question

On the basis of historical data, Richard Tenant, a business historian who studied the tobacco industry,[1] has concluded:

“The consumption of cigarettes is [relatively] insensitive to changes in price…In contrast, the demand for individual brands is highly elastic in its response to price…In 1918, for example, Lucky Strike was sold for a short time at a higher retail price than Camel or Chesterfield and rapidly lost half its business”

1. Explain why the demand for a particular brand is more elastic than the demand for all cigarettes.
2. Do you think that the demand curve for cigarettes is the same now as it was in 1918? If not, describe in detail all the factors you can think of that may have shifted the curve and whether each factor shifted the curve to the right or to the left. Draw a graph (like the ones we have used in class) that illustrates at least one of these changes.

Answer 1

The problem is related with the consumption of cigarettes. Historical data states that consumption of cigarette is relatively insensitive to price. It will mean smokers of cigarette do not substitute it by taking some other products like cigars. bidis, tobaccos etc. Also number of packets consumed per day is also relatively static for them. They are habituted to take this quantity, irrespective of their price. So price-demand relation of cigarettes is highly inelastic.

But if you consider the brand, then situatrion will differ. Smokers are not fond of any particular brand. For them, brands are highly substitutable. The products of different maufacturers are almost homogeneous to them. As a result price becomes crucial here. They always go for a brand which is lower in price. Thus elasticity of a brand (i.e. elasticity of demand of a particular manufacturer is highlly price sensitiver. One percent change in the price of a brand will change its demand by more than one percent in opposite direction. Here elasticity will be more than 1.

Thus if Lucky Strike raises its price by 1% in 1918, then price elasticity will be definitely more than 1. But it is not possible to say that it will be greater than 2. It may or may not be observed.

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Answer b: Demand for cigarettes will not be the same now as it was in 1918. It may be due to may factors that will shift the curve in either direction.

1. Habit: Smoking habit is a crucial factor in determiinig its demand. If more percetage of people are habituated now, then the demand curve will shift to the right.

2. With the increase in knowledge, many people are aware about the bad effect of taking cigarettes. so they are now more health concious now. It has helped in reducing the numbers of cigarettes smokers now. So demand has shifted to the left now.

3. Popultion of today is much higher than population of 1918. So inspite of awareness, number of smokers in absolute term must be higher now. Hence demand curve is expected to shift to the right now.

4. with the passing of time, many new substitutes of cigarettes are developed. A portion of peopl;e are attracted to these products. Thus demand curve now is expected to shift to the left now.

So ultimate shift in the demad curve today will be the combined effect of all factors stated above..