Question

The estimated price elasticity of demand for cigarettes is -0.4 in high- income countries and -0.8 in lower-income countries. If a country's government raises taxes on cigarettes, the price to consumers goes up. The extra revenue collected from the higher price goes to the government. Would imposing a new tax on cigarettes stop more people from smoking in a high or lower-income country? O The tax would not be very effective at reducing smoking in either country, but it would be more effective in a higher-income country. O The tax would be very effective at reducing smoking in both countries, but it would be more effective in a lower-income country. O There is not enough information available to answer the question. O The tax would be very effective at reducing smoking in both countries, but it would be more effective in a higher-income country. The tax would not be very effective at reducing smoking in either country, but it would be more effective in a lower-income country. O The tax would not reduce smoking in either country.

Answer 1

(1) (E)

Absolute value of elasticity of demand (Ed) is less than 1 in both countries, so the increase in price (caused by tax) will decrease quantity demanded less than proportionately, not making the tax very effective. But since absolute value of Ed is less in high-income countries, relative effectiveness of tax is higher in the lower-income countries.

(2) (D)

The lower the absolute value of Ed, the higher the tax revenue.