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Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a packet of cigarettes currently costs £2 and the government wants reduce smoking by 20 per cent, by how much should they increase the price?
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(a) Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a packet of cigarettes currently costs £2 and the government wants reduce smoking by 20 per cent, by how much should they increase the price? Price elasticity of demand is equal to proportionate change in quantity demanded divided by the proportionate change in price, and so to calculate how much the government should increase the price of cigarettes to, the formula must be rearranged into the form, proportionate change in quantity divided by the price elasticity of demand, and so to calculate the new price of cigarettes we must divide 20 by 0.4, to get the percentage increase which is 50 percent. Therefore the new price for cigarettes will be £3. (b) If the government permanently increases the price of cigarettes, will the policy have a larger effect on smoking one year from now or five years...
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