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 25% 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, would you say the tax hike worked best in the short-run 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 e-cigarettes to be relatively more or less price elastic compared to the demand for regular cigarettes?

Answer 1

(a)

Cigarette is an addictive commodity. In short-run, it is very difficult to reduce intake of addictive substance or find its effective substitution. However, in logn-run, it is possible to reduce the intake of addictive substance or find its effective substitute.

So, demand for addictive substance such as cigarettes is less elastic in short-run compared to long-run.

Thus, the estimate -0.4 pertains to short-run while the estimate -0.8 pertains to long-run.

(b)

In short-run,

Price elasticity of demand = -0.4

Percentage change in price = 25%

Price elasticity of demand = % change in quantity demanded/% change in price

-0.4 = % change in quantity demanded/25

% change in quantity demanded = -10

Thus, in short-run, the quantity demanded for cigarettes will decrease by 10 percent.

In long-run,

Price elasticity of demand = -0.8

Percentage change in price = 25%

Price elasticity of demand = % change in quantity demanded/% change in price

-0.8 = % change in quantity demanded/25

% change in quantity demanded = -20

Thus, in long-run, the quantity demanded for cigarettes will decrease by 20 percent.

(c)

It can be seen that tax hike has resulted in greater change in quantity demanded in long-run relative to the short-run.

Thus, it can be stated that the tax hike worked best in the long-run, if the aim was to reduce negative consequences of smoking.

(d)

If e-cigarettes are more addictive compared to regular cigarettes then demand for e-cigarettes would be relatively less price elastic compared to the demand for regular cigarettes.