Question

Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a pack of cigarettes currently costs $4 and the government wants to reduce smoking by 20 per cent, by how much should it increase the price?

Answer 1

To reduce cigarette consumption by 20%, prices must increase by 50%. With a current price of $4, the price should rise to $6 per pack considering the price elasticity of demand is 0.4.

Step-by-step explanation:

The question relates to the economic concept of price elasticity of demand and attempts to calculate the required change in price to achieve a specific reduction in quantity demanded. Given that the price elasticity of demand for cigarettes is 0.4, and considering that a 20% reduction in smoking is desired, we use the elasticity formula:

Elasticity (E) = Percentage change in quantity demanded / Percentage change in price

Therefore, to find the percentage change in price needed, we rearrange the formula:

Percentage change in price = Percentage change in quantity demanded / Elasticity

Percentage change in price = -20% / 0.4 = -50%

This indicates that the price would need to increase by 50% to reduce the quantity of cigarettes demanded by 20%. Since the current price is $4, a 50% increase would equal $2, meaning the new price should be $4 + $2 = $6 per pack.