Question

If studies suggest that the price elasticity of demand for cigarettes is 0.2 (in absolute terms), and the government wishes to decrease cigarette consumption by 25%, how much of a price increase by taxation would be required to bring this about?

Is this policy to reduce smoking likely to have:

(a) a larger effect in the longer term than in the shorter term?

(b) a larger effect on younger smokers than older smokers?

Answer 1

Price elasticity of demand = % decrease in consumption or demand / % increase in price

.2 = 25%/% increase in price

% increase in price = 25%/.2

% increase in price = 125%

So, price should be increased by 125% to bring a decrease in consumption by 25%.

---

A

True. The policy will not be able to work effectively, in the short run, because people cannot change their consumption without finding alternatives. Further, consumers need time to change their habit to reduce consumption and it is only possible in the long run. Hence, long run time, there will be greater impact of the policy.

---

B.

True

The policy has larger effect upon the young smokers, because they lack the purchasing power and they can change their habit of smoking as they are new to the smoking. But, it is not so effective for the old smokers who are addicted and they have the purchasing power to buy products even if the price increases.