Question

I N T H E N E W S Professor Becker Rejects Clinton's Tax Math In seeking ways to balance the federal budget, President Clinton has seized on the excise tax on cigarettes. That tax, now at 24 cents per pack, brought in around $12 billion in federal revenue last year. President Clinton says that raising that tax by $1 a pack could generate another $53 billion over the next five years. Chicago professor and Nobel laureate Gary Becker says the president is blowing smoke. A quadrupling of the excise tax will convince a lot of smokers to quit—or at least smoke less. Because smoking is addictive, the decline in smoking won’t be immediate. In the short run every 10 percent hike in the price of cigarettes will reduce consumption by only 4 percent. But in the long run, smoking will decline by about 7 percent. As a result, the tax hike will bring in only a fraction of what Clinton anticipates. Source: Media reports, 1994. According to Professor Becker, by how much would cigarette prices have to rise to get 15 percent reduction in smoking? a. One year Percent b Three years percent I am having a hard time with setting up the problem for these, please provide how to set up as I am trying to teach myself through online classes.

Answer 1

a) According to Professor Becker, In the short run (1 year) every 10% hike in the price of cigarettes will reduce consumption by only 4%.

So, Price Elasticity in the short run = Percentage change in Quantity demanded / Percentage change in price

Price Elasticity = -4% / 10%

So Price Elasticity = -0.4

In order to reduce the quantity demanded by 15%, the price need to rise by :

-0.4 = -15% / Percentage change in Price

Percentage change in Price = -15 / -0.4

= 37.5%

Thus in One Year, the price of cigarettes has to increase by 37.5% in order to reduce the smoking by 15%.

b) In the long run, every 10% hike in the price of cigarettes will reduce consumption by about 7%.

So, Price Elasticity = -7% / 10%

Price Elasticity = -0.7

In order to reduce the quantity demanded by 15%, the price need to rise by :

-0.7 = -15% / Percentage change in Price

Percentage change in Price = -15 / -0.7

= 21.4%

Thus in Three Years, the price of cigarettes has to increase by 21.4% in order to reduce the smoking by 15%.