Instructions: Enter your response as a percent rounded to one decimal place. per

Question

Instructions: Enter your response as a percent rounded to one decimal place.

percent

(c) Refer to the “In the News” below:

President Clinton has seized upon the cigarette excise tax as an expedient and politically correct means of increasing federal revenue. In 1994 the federal government took in $12 billion from the present 24-cents-per-pack tax. If the tax were quadrupled to $1 a pack, Clinton figures tax revenues would increase by more than $50 billion over three years. Those added revenues would help finance the health care reforms the president so dearly wants.      

Professor Gary Becker, a Nobel Prize–winning economist at the University of Chicago, says Clinton’s math is wrong. The White House assumed that cigarette sales would drop by 4 percent for every 10 percent increase in price. Professor Becker says that reflects only the first-year response to higher prices, not the full adjustment of smokers’ behavior. Over a three-year period, cigarette consumption is likely to decline by 8 percent for every 10 percent increase in price—twice as much as Clinton assumed. As a result, the $1-a-pack tax will bring in much less revenue than President Clinton projected.

Source: Gary S. Becker, "Warning: A Higher Cigarette Tax May Be Hazardous to Health Financing," BusinessWeek, August 15, 1994, p. 18.

According to Gary Becker, by how much will sales decline in the long run?

Instructions: Enter your response as a percent rounded to one decimal place.

Product Price Elasticity Relatively elastic ( E > 1 )   Airline travel, long run 2.4   Restaurant meals 2.3   Fresh fish 2.2   New cars, short run        1.2 - 1.5 Unitary elastic ( E = 1)   Private education 1.1   Radios and televisions 1.2   Shoes 0.9   Movies 0.9 Relatively inelastic ( E < 1 )   Cigarettes 0.4   Coffee 0.3   Gasoline, short run 0.2   Electricity (in homes) 0.1   Long-distance phone calls 0.1

Explanation / Answer

a) Percent change in Price = Change in Price / Average Price = P2-P1 / (p2+p1)/2 = 6-5 / (6+5)/2 = 1 / 5.5 = 0.181 = 18.1%

b) Percent change in price = 18.1% and the good Cigarettes comes under the category where price elasticty is less than 1. Which is 0.4 for Cigarettes. Thus, Percent cahnge in demand due to change in price = 0.4 * Percent change in price 18.1% = 7.27 %

Thus, By 7.2% percentage cigarette sales will decline in the short run.

c) percent decline in demand in long run = 0.8 * 18.1 = 14.5%

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