According to a study of US cigarette sales between 1955 and 1985, when the price

Question

According to a study of US cigarette sales between 1955 and 1985, when the price of cigarettes was 1% higher, consumption would be 0.4% lower in the short run and 0.75% lower in the long run (Becker et al., 1994).

a. Calculate the short and long run price elasticities of the demand for cigarettes.

b. Is demand more or less elastic in the long run than in the short run? Explain your answer.

c. If the government were to impose a tax that raised the price of cigarettes by 5 percent, would total consumer expenditure on cigarettes (hint: which is total revenue for the firms) rise or fall in the short run? What about in the long run?

Explanation / Answer

a. Elasticity = % change in demand/% change in prices

Short-run elasticity = -0.4/1 = -0.4

Long-run elasticity = -0.75/1 = -0.75

b. The demand is more elastic in the long-run. The consumption is more responsive to change in prices in the long run as shown by the data. The same 1% increase in prices induces people to decrease demand by 0.4% in the short-run but the decrease is much more in the long-run when it declines by 0.75%. The higher absolute value of long-term elasticity captures this.

c. Short-Term: The total expenditure on cigarettes would increase in the short-run as the short-term demand is inelastic (absolute value of short term elasticity = 0.4 < 1).

Long-Term: The total expenditure on cigarettes would increase in the long-term as the long-term demand is inelastic (absolute value of long-term elasticity = 0.75 < 1).

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