Question

Assume that, according to empirical research

1. the price elasticity of demand for cigarettes is 0.6;
2. low income families spend too much on cigarettes and don’t buy enough milk for their children.

To remedy this situation, a legislator recommends to increase substantially the tax on cigarettes. This would discourage poor people from smoking, as a consequence, they will spend less on cigarettes and more on milk. Is the legislator right or wrong, and why?

Be as specific as possible.

Answer 1

Answer is No. The increase in tax on cigarettes will increase the tax revenue of government but may not make people to buy less cigarettes because the demand for cigarettes is price inelastic. When percentage change in demand is less than percentage change in price the demand is said to be inelastic. The price elasticity of demand will be less than 1 and as 0.6 in case of cigarettes. With increase in price due to tax will not make people to consumer or demand less cigarettes as people are habitual to smoke.   So legislator recommendation may not work in case of goods that are price inelastic.