Question

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

Answer 1

Government should increase the price from $2 to $3.

Step-by-step explanation:

Price elasticity of demand is calculated by dividing percentage change in quantity demanded by the percentage change in price.

Therefore:

Price elasticity of demand =
`(percentage change in quantity demanded)/(percentage change in price)`

From the question, we see that the price elasticity of demand for cigarettes is about 0.4.

Percentage reduction in quantity demanded = 20%

Percentage reduction in price = x

We calculate thus:

0.4 = 20/x

0.4x = 20

x = 20/0.4

x = 50

Percentage reduction in price is therefore 50%

This means that government should increase the price from $2 to $3.