Question

Consider public policy aimed at smoking.A. Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a pack of cigarettes currently costs $5 and the government wants to reduce smoking by 20%, by how much should it increase the price?B. If the government permanently increases the price of cigarettes, will the policy have a larger effect on smoking 1 year from now or 5 years from now?

C. Studies also find out that teenagers have a higher price elasticity than do adults. Why might this be true?

Answer 1

A. Elasticity measure the change in quantity demanded that comes with a change in price. The elasticity formula is;

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

0.4 = 20% / %change in price

%Change in price = 20%/0.4

= 0.5

= Increase price by 50%

= 50% * 5 = $2.50

Government should increase the price by $2.50 to make it $7.50.

B. Effect is larger 5 years from now

Effect will be larger 5 years from now than 1 year from now. This is because in 5 years the high prices would have forced smokers to look for more alternatives to smoking than in a year.

C. Teenagers have less income.

Teenagers likely have a higher price elasticity because they do not have the income to support an increase in the price of cigarettes so when the prices increase, they buy less than adults who are more likely to have an income stream.