Question

a) Price elasticity of demand for cigarettes is -0.5 in the short-run. Currently, the price per pack of cigarettes is $5.50 in Louisiana. $0.86 of this price is state tax and about $1 of the price is federal tax. Each year 350 million packs of cigarettes are sold in Louisiana. If the state government increases the state tax to $1.08 per pack, what would be the new state tax receipts from cigarettes after this tax increase? b) How would your answer to (a) change if you entertain the possibility of cross-border consumption? (people moving across state borders to buy cigarettes) DO NOT ASSERT! ANALYZE LIKE AN ECONOMIST! c) What will happen to tax revenues in the long-run? Why?

Answer 1

The price elasticity oof demand here is negative means, when the prices increases the quantity demanded will decrease. If the stategovernment increases the tax rate to $1.08 per pack the new state tax receipts would be . It would add a 63 million to state tax

a) The price elasticity of demand is negativie here, so an increase in the taxes means the rise in the prices of cigarettes, so people will consume less of it, it also may lead to the cross-border consumption. So they will buy cigaettes from another country.

c) The increse in the price of cigarettes will be the one is intended to protect the health of the people so once they ncreased they wont reduce tax rate. If the people go for the cross-border consumption there will be decrease in the tax revenues in the long run. If the people dont go for the cross-border consumption this will create more tax revenues for the government in the long run.