Question

Consider public policy aimed at smoking. 

a. Studies indicate that the price elasticity of demand for cigarettes is about 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? 

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

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

Answer 1

Elasticity = % change in quantity / % change in price

-0.40 = -20%/x

x = 20% / 0.40 = 50%

Govt should increase the prices by 50%.

The policy should have a larger effect in the short term than in the long term, as over a period of 5 years people's income will grow makinig them demand more of cigarettes.

Since the teenagers would have a small amount of money they can spend on cigarettes per period without an ability to increase the amount if the price goes up, their demand would be more elastic. Note that with elasticity of 0.40, a price raise leads to an increase in amount spent. The teenagers won't be raising the amount they spend on cigarettes, resulting in a higher elasticity.