Question

Suppose that the price elasticity of demand for cigarettes is -0.40 for adults and -0.71 for youths. Use this information to describe the likely impact of a tax hike on cigarettes for adults and youth in terms of quantity of cigarettes purchased and revenue from the tax. Illustrate with a graph how a tax of $1 per pack on cigarettes affects the price of cigarettes to the consumer and the amount received by the producer. Clearly label the equilibrium price prior to the tax, the equilibrium price following the tax, and the amount received by the producer after the tax.

Answer 1

Price elasticity of demand for cigarettes is -0.40 for adults and -0.71 for youths.

Tax hike on cigarettes for adults and youth

Demand for cigarettes is relatively inelastic for adults and elastic for youths

This implies that demand curve is steeper for adults and flatter for youths.

Supply curve is fairly elastic

A tax of size 't' on each cigarette is imposed in both markets which shifts the demand curve to the left / down

In both markets, price paid by buyers rises and price received by sellers declines. Sales also drop

In the market for cigarettes for adults (part a), this tax raises price for adult consumers more than the rise in price for youth (part b)

This price is P1

This happens because the demand by adults is inelastic which means they bear a greater tax burden

Price for sellers declines to P2

Quantity also declines to Q1