Consider public policy aimed at smoking.?

Question

a) Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a packet of cigarettes currently costs $8 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?

Answer 1

a)

E= -0.4 = ΔQ% / ΔP%

ΔQ% = -20%

-0.4 = -20% / ΔP%

ΔP% = -20% / -0.4 = +50%

P=$8 + 50% = $8+$4 = $12

ΔP = +$4

b)

In short-run demand is less elastic comparing to longer-run, thus in short-run (1 year) there might be higher effect on smoking than in longer-run (5 years).