Daily Economics Lessons from Daniel Hamermesh;
The Economist has an article about the worldwide health problem caused by cigarette smoking. It summarizes studies by economists showing that “raising tobacco taxes by a tenth [10%] may cause a 4% drop in consumption in rich countries …, with tax revenues rising despite lower sales.” No question—if taxes rise by 10% and sales only fall 4%, tax revenues will rise—by about 6%. But I wonder if the studies are not too optimistic about the effect on sales. In the U.S the median tax rate is $0.80. Let’s say the average price per pack is $3.20. Then a tax increase of 10% means a price increase of less than 3%, so if sales fall by 4%, the implied price elasticity of demand is 4%/3% = 1.33. Is the demand for cigarettes really that elastic? I doubt it.