Question

Recently the governor of Massachusetts proposed that cigarette taxes in Massachusetts should be increased substantially, from 55 cents a pack to 76 cents a pack. He estimates that Massachusetts can raise $40 million in revenue from this tax hike. He also pointed out that the neighboring state of Connecticut was considering an increase in cigarette taxes. How can it be that an increase in cigarette taxes will increase tax revenue, because, after all, a higher tax will increase cigarette prices and thereby decrease the quantity demanded

Answer 1

When a price increase does not result in proportionally lower quantity demanded it means that the price elasticity of demand is inelastic or ≤ |1| in absolute terms.

Nicotine is a drug, and drugs are addictive. That means that cigarette users are probably addicted to nicotine, and any increase in price will not affect the quantity sold, or its effect will be very low.

The most common example of inelastic goods are gasoline, electricity, and other utilities which have very low price elasticities. A price increase barely affects the quantity demanded.