Question

A study reported that a 10% increase in the price of cigarettes would reduce consumption by 4% in the short-run and by 7.5% in the long-run. Use this information to calculate the price elasticity of demand for cigarettes in both the short-run and the long-run. Based on these estimates, what happens to the price elasticity of demand for cigarettes as more time elapses since the change in price? Briefly explain why this may happen.

Answer 1

Price elasticity of demand shows how much a 1% change in the price of a good or services changes the quantity demanded.

In the short run, a 10% increase in price decreases quantity demanded by 4%

PED short run = % change in price / % change in quantity = 4% / 10% = 0.4

PED long run = % change in price / % change in quantity = 7.5% / 10% = 0.75

Both PEDs are inelastic since they are less than 1, which means that an increase in price will result in a proportionally smaller decrease in the quantity demanded. But the PED in the long run is less inelastic, which means that an increase in price will decrease the quantity demanded more in the long than in the short run.

This happens because smokes consider that cigarettes are a basic necessity, so they are willing to purchase them even if the price increases. But as time passes (long run), more smokers will consider that it is not worth paying that much for cigarettes and will probably quit smoking or at least reduce the number of cigarettes they smoke per day.