Question

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Half of US states have minimum cigarette price laws prohibit cigarettes from being sold below a minimum price. These were originally passed to protect small independent retailers from unfair price competition with larger retailers. New York State has the most stringent minimum price law because it doesn’t allow promotional incentive programs to lower the minimum price.

Most existing minimum cigarette price laws allow the use of promotions which reduce cigarette prices. A 2005 study (see footnote) found that cigarette prices are not significantly different in US states with and without cigarette minimum price laws except NY. Cigarette prices were significantly higher in New York stores, leading the study to conclude that New York's strategy to disallow types of incentives results in higher minimum cigarette prices.

The authors of the 2005 study claim that use of stringent minimum price laws “should be explored as a potential policy strategy to control cigarette company marketing practices in stores. Strict cigarette minimum price laws may have the potential to reduce cigarette consumption.”[i]

1. Illustrate (i.e. use diagrams) to show why the minimum price laws in most states are ineffective.

2. Support DIAGRAMMATICALLY the authors’ claim that a minimum price law like the one in NY state will accomplish reduction in consumption.

Answer 1

Answer:

a. Minimum price laws in most states are due to the nature of elasticity of demand and supply curves. Demand curve is inelastic compared to the supply curve because smokers are habituated to cigarettes, so a price hike will not make much difference to them. Moreover, cigarettes do not have one-to-one substitutes.

Graph:

Quantle

As the above graph illustrates, the increase in price due to minimum price does not bring the consumption down proportionately. This is because of the inelastic nature of demand curve.

The second reason for the failure is that many minimum price laws require that a percentage mark-up levied on cigarettes. Many laws also allow price promotions to reduce the minimum price level. P2 is brought closer to P1 or even coincide with P1 due to price promotions . So these measures of minimum price laws are ineffective in most states.

b. In the state of NY:

In New York, the minimum price is much higher than the equilibrium price. Moreover, retailers are not allowed to use any price promotional deals either. So the quantity of smokers decreases.

Graph:

Quantity

There is income effect to this too. Smokers, especially from lower income groups find it difficult to buy cigarettes when they cost more to them, but without any increase in their incomes. So they will smoke less now or quit completely depending on ow much it affects their finances.

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