question archive Consider a public policy aimed at smoking The government commissioned a research firm, Super Consulting, to conduct a study on the market demand for cigarettes in Malaysia
Consider a public policy aimed at smoking The government commissioned a research firm, Super Consulting, to conduct a study on the market demand for cigarettes in Malaysia
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Consider a public policy aimed at smoking
The government commissioned a research firm, Super Consulting, to conduct a study on the market demand for cigarettes in Malaysia. The firm reported that the price elasticity of demand for cigarettes is about 0.4. If a pack of cigarettes costs $2 and the government wants to reduce smoking by 20 percent, by how much should it increase the price?
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Answer:
Price elasticity of demand is 0.4
Pack of cigarettes costs $2
and the government wants to reduce smoking by 20%
Price elasticity of demand is given by % Change in Quantity demanded / % Change in Price
0.4 = 20% / % Change in price
% Change in Price = 20% / 0.4
% Change in Price = 50%
Thus as demand for smoking declines price will have to increase by 50%
% Change in Price = [ (New price - Old Price) / Old Price ] * 100
Or [ ( New Price / Old Price ) - 1 ] * 100
50% = [ ( New Price / $2 ) - 1 ] * 100
2 * 1.50
= $3
[ ( $3 / $2 ) - 1 ] * 100
= ( 1.50 - 1) * 100
= 0.50*100
= 50%
Thus the price will have to be increased by 50% to $3
