10 Problems and Applications Q10 Consider public policy aime

10. Problems and Applications Q10 Consider public policy aimed at smoking. Studies indicate that the price elasticity of demand for cigarettes is about 0.8. If a pack of cigarettes currently costs $5 and the government wants to reduce smoking by 20%, it should increase the price by If the government permanently increases the price of cigarettes, the effect on smoking 1 year from now will be than the effect 5 years from now. larger Studies also find that teenagers have a higher price elasticity of demand than do adults. smaller Which of the following statements are consistent with this result? Check all that apply. Teenagers do not have as much income as adults, so they are more price sensitive. It is legal for adults to consume alcohol, so many choose to spend their money on that good rather than cigarettes. Adults are more likely to be addicted to cigarettes.

Solution

Price elasticity of demand for cigarettes is about 0.8.

Government wants to reduce smoking by 20%.

This implies that percentage change (decrease) in quantity demanded is 20%.

Calculate % increase in price -

% increase in price = % change (decrease) in quantity demanded/Price elasticity of demand

% increase in price = 20/0.8 = 25%

The government should increase the price by 25%.

The value of the price elasticity of demand for cigarettes is less than 1. This implies that demand for cigarettes is inelastic.

In case of inelastic demand, larger is the time period, greater will be the impact on quantity demanded and vice-versa.

So,

If the government permanently increases the price of cigarettes, the effect on smoking 1 year from now will be smaller than the effect 5 years from now.

Teenagers have a higher elasticity of demand than do adults because of the following two reasons -

1. Teenagers do not have much income as adults, so they are more price sensitive.

2. Adults are more likely to be addicted to cigarettes.

Hence, the correct answer is the option (1) and (3).