Question

Why do local and state governments like raising the taxes on cigarettes?

Multiple Choice

• Most long-term smokers are hooked on smoking and can’t stop this habit. Therefore, they have an inelastic demand curve and the government is simply able to take advantage of this.

• In these cases, the government is usually able to collect more tax revenues because the demand is inelastic.

• The U.S. government has traditionally set a "price floor" on tobacco prices (this is a true fact). Therefore, this gives an incentive to the tobacco farmers to grow more tobacco. If more people get hooked om smoking, then that means more revenues for the tobacco industry and more tax revenues for the government.   

• All of the answers above are true and correct.

Answer 1

One of the determinants of the elasticity of demand is the habit of the consumers. The goods on which the consumers are habitually addicted will have inelastic demand. Example cigarettes and liquor. In case of inelastic demand the demand does not decrease more with increase in price. Thus if the government impose tax on the cigarettes the government can collect more taxes.

When the government set a price floor, the manufactures will have more incentive to produce more and in the context of inelastic demand the government can get more revenue while ensuring more revenue to the tobacco farmers.

Answer: All the above are true and correct.