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According to studies undertaken by the US Department of Agriculture, the price elasticity of demand for cigarettes is between - 0.3 and - 0.4 and the income elasticity is about + 0.5.

a. Suppose Congress, influenced by studies linking cigarette smoking to cancer, plans to raise the excise tax on cigarettes so the price rises by 10%. Estimate the effect the price increase will have on cigarette consumption and consumer spending on cigarettes (in percentage terms).

b. Suppose a major brokerage firm advised its clients to buy cigarette stocks under the assumption that, if consumer incomes rise by 50% as expected over the next decade, cigarette sales will double. What is your reaction to this investment advice?

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Microeconomics, Economics

Category:- Microeconomics
Reference No.:- M91233984

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