Question

Studies suggest that the price elasticity of demand for cigarettes is 0.34. The government is concerned about the health effects of smoking. If the government increases the price of cigarettes by 20%, would smoking be reduced? Explain the reason for your answer. If the increase in the price of cigarettes is permanent, will the policy be more effective in reducing smoking in the current year or 5 years from now? Why?

Answer 1

Increasing the price of cigarette by 20% will be not reduce smoking. This is because elasticity of 0.34 means that the demand for the product is inelastic and therefore a price change will have little or no effect on demand.

If the policy on price increase is permanent, it will be effective 5 years from now. That time people will realize the amount of funds they are spending on the cigarettes and will start shiftiness their consumption but will not be immediately.