Question

1. Studies indicate that the price elasticity of demand for cigarettes is around 0.4. If a pack of cigarettes currently costs $2 and the government wants to reduce smoking by 20 percent, by how much should it increase the price?

2. If the government permanently increases the price of cigarettes will the policy have a larger effect on smoking 1 ear from now or 5 years from now?

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

4. The equilibrium price of cigarettes rose sharply last month, but the equilibrium quantity was the same as ever. Three people tried to explain the situation. Which explanations could be right? Explain your logic.

Person 1: Demand icnreased, but supply was totally inelastic

Person 2: Supply increased but so did demand

Person 3: Supply decreased, but demand was totally inelastic.

Answer 1

1. Given that price elasticity of demand for cigarettes = 0.4. We know that elasticity = % change in Qd / % change in price.

A pack of cigarettes currently costs $2. Government wants to reduce smoking consumption by 20 percent. This implies that % fall in the quantity demanded should be 20%. The required increase in price is

-0.4 = 20%/% change in price

% change in price. = -50%

Hence price should increase by 50% from $2 to $3 per pack.

2. If the government permanently increases the price of cigarettes, the policy will havea larger effect on smoking 5 years from now. This is because smoking is an addiction which needs time if somebody is willing to give up smoking. Note that smokers usually do not reduce their consumption of smoking or give up smoking when price is increased. With time they may look for other additions like e-cigarettes, or try to giving it up altogether. Longer the period for adjustment, magnified the effects will be.

3. Studies also find that teenagers have a higher price elasticity of demand than do adults. This is because teenagers' addiction level is weak so they are not willing to pay a higher price for cigarettes. T

4. The equilibrium price of cigarettes rose sharply last month, but the equilibrium quantity was the same as ever. The correct logic is that Demand icnreased, but supply was totally inelastic which would resulted in all the increase in demand to be absorbed by the price so that quantity remained unchanged. Hence person 1 is correct.