Question

Consider public policy aimed at smoking

a.Studies indicate that the price elasticity of demand for cigarettes is about 0.4.If a packet of cigarettes is currently priced at £6 and the government want to reduce smoking by 20%, by how much should it increase the price?

b.If the government permanently increases the price of cigarettes, will the policy have a larger effect on smoking one year from now or five years from now?

c.Studies also find that teenagers have a higher price elasticity of demand for cigarettes than do adults. Why might this be true?

Answer 1

Ed = % Change in Quantity demanded/% Change in Price

0.4 = 20/% Change in Price

%Change in Price = 20/0.4 = 50%

The government wants to reduce smoking, so it must increase the price by 50%. The new price will be 6*(1.50) = £9

If the government increases the price of cigarettes permanently, there will be a larger effect five years from now than one year from now. The reason behind this is that people who smoke are habitual and it may take more time to get rid of it or reduce the consumption of cigarette. Thus the elasticity is larger in the long run.

Studies also find that teenagers have a higher price elasticity of demand for cigarettes than do adults, this may be true as the teenagers generally have a lower income. This prompts the demand of cigarettes by teenagers to be more elastic than the adults who are earning and can absorb an increase in price without affecting their demand. Thus demand of cigarettes by adults is less elastic than teenagerss.