Consider public policy aimed at smoking. a. Studies indicate...

Consider public policy aimed at smoking. a. Studies indicate that the price elasticity of demand for cigarettes is about $0.4 .$ If a pack of cigarettes currently costs $\$ 5$ and the government wants to reduce smoking by 20 percent, by how much should it increase the price? b. If the government permanently increases the price of cigarettes, will the policy have a larger effect on smoking 1 year from now or 5 years from now? c. Studies also find that teenagers have a higher price elasticity of demand than adults. Why might this be true?

Transcript

00:01 So here we have a series of questions about taxing smoking.

00:03 The first one deals with elasticity.

00:06 Let's remind ourselves that elasticity is equal to the percent change in quantity over the percent change in price.

00:12 That's just the definition of elasticity.

00:15 And now if i fill this in, we have an elasticity of 0 .4 and inelastic, we're indicating that people like to keep smoking even when the price goes up.

00:27 We want to reduce the amount of smoking by 20%.

00:34 So we want minus 20 % change in quantity, and we need to solve for the resulting change in price that will generate the corresponding change in quantity.

00:45 So if i rearrange this equation, i get the percent change in price is equal to minus 20 % divided by 0 .4, which is equal, oh sorry, we have to be very careful.

00:59 They dropped the negative sign on elasticity.

01:02 Elasticity should be negative, right? because demand curves slope down.

01:06 But when elasticity is always negative, economists have a lazy habit of just saying 0 .4, even though they really mean negative .4.

01:16 But elasticity of demand should always be negative unless you think the demand curve is sloping up.

01:21 So this is really minus 0 .4, which means, that we need to increase prices by plus 50%.

01:29 I knew i'd made a mistake there, or at least there had been an omission in the question because prices have to go up to deter smoking, right? so we need to increase the price by 50%.

01:41 So if the old price was $5, the new price should be $750 for plus $250, right? because we're increasing by 50%...

Question

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