Question

4. A senator in a certain state proposes to reduce the state's cigarette-tax. His reasoning is that this would reduce cigarette prices, which in turn would make people buy more cigarettes. Therefore, he concludes, the total cigarette-tax revenues collected by the state would increase Demand for cigarettes have been found by many studies to be price-inelastic a) Give one possible reason why demand for cigarettes is inelastic. b) Do you agree with the senator's logic? Explain your answer briefly but clearly, using economic terms and models that we have discussed in Econ 202

Answer 1

Price elasticity of demand is an economic measure of change in the quantity demanded or purchased of a product in relation to its price change. Expressed mathematically as:

Price Elasticity of demand =%Change in Quantity Demanded/ % Change in Price

When the demand for a commodity does not change much in response to a change in its price, it is known as Price Inelastic. The more discretionary a purchase is, the more its quantity will fall in response to price rise. On the other hand, the less discretionary a commodity is, the less its quantity demanded will fall. Examples of price inelastic commodities are luxury items ( where shoppers pay for the priviledge of buying a brand name), addictive products like alcohol and tobacco, and required add-on products like ink cartridge for printers, notebooks etc.

Ans a.) Cigarettes are an example of addictive products. Inspite of a change in its price (esp. rise) there is not much change in its demand ( here fall).

Ans b.) With reference to the above explanation we can easily see that the demand of addictive products like cigarettes does not change much in response to a change in its price. Hence Sin taxes on addictive products are possible to be introduced because the lost tax revenue from fewer units sold is exceeded by the higher taxes on units still sold.

So in my opinion, i would disagree with senator's as far as it is related to cigarettes as commodity. ( In case of other non addictive products or other consumables, senators logic may be right.)