A large body of research has found that price elasticity for cigarette demand is about -

Answer to question parts (a) - (d):

a) Price elasticity of cigarette demand is -0.4. The absolute value of price elasticity of demand = 0.4

Price elasticity of demand = (%change in quantity demanded/ % change in price)

The value of PED tells us that % change in quantity demanded < % change in price. It means even if the price of cigarettes rises by a relatively larger amount, consumption falls by relatively smaller amount, and vice versa.

b) The absolute value of price elasticity of demand is less than 1. This means the demand for cigarettes is price inelastic.

C) As the demand is price inelastic, a large increase in price will reduce the quantity demanded by a relatively smaller amount. This will increase the total revenue. The opposite will happen if price decreases.

It means if the cigarette manufacturers increase prices, the sales revenue will increase.

d) The government imposes a $1 per pack cigarette taxes. Both buyers and sellers will bear the tax burden. Therefore, the retail prices of cigarettes will rise by less than $1. Equilibrium quantity of cigarettes sold will decrease because of the increase in price.