Since economists use the estimates of the price elasticity of demand to quantify the impact of a change in price on consumption. Since the tax can change the price and thus change demand, therefore, it can be assessed with price elasticity. The estimate of price elasticity of demand of cigarette from the USA and other high income countries falls in the range of -0. 25 to -0. 50 (Chalklike and Warner, AAA, Bibb). The addictiveness of smoking and whether the smoker is young or adult are the two factors can influence price elasticity. The slope of price- consumption curve for cigarettes is upward. Assume that all smokers allocate income between smoking cigarettes and “other” goods and consider both of them as normal goods. Using a diagrammatically analysis, explain why a young smokers adjustment to a price increase in cigarettes differs from that of an adult smoker. This part will use the income effect and substitution effect of normal goods when the price increases to analyze the difference of the adjustment of young smoker and adult smokers to price changes. The following figure shows the case of young smoker. OX and OX represent the quantity of cigarette consumption and other odds respectively.

Both of them are normal goods. As shown in the above figure, before the price change, the consumer budget line is ABA line and it is tangent with indifference curve at point a, which is an utility minimization point. At the point a, the consumption quantity of cigarette of young smoker is Ox, now we assumes that the price of cigarette increase from Pl to UP and push the budget line move to AD. The new budget line is tangent with the indifference curve IIS at the point c which has a lower utility level than point a. At the point b, the consumption quality of cigarette of young mocker is Cox.

Comparing the point a and point c, the change of quantity of cigarette consumption is Ajax. This is the total effect of price increase on the cigarette consumption of young smokers. This total effect can be divided by the income effect and substitution effect. We can draw a compensated budget line FIG which is tangent with LU at point b. We can find that when the point price increase, the relative price is changed and the utility minimization point moved from point “a” to point “b”. The quantity reduced by Saab, which is substitution effect and negative.

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With the increase of price, the real income level of young smokers decreased and makes the utility minimization point moved from point “b” to point “c”. The quantity of cigarette consumption reduces by Xebec, which is income effect and negative. Therefore, when the price increases, young smokers would reduce the consumption of cigarette due to income effect and substitution effect. However, adult smokers have higher level of income level than young smokers and thus income effect will be weakening. Then the total effect of price increase of cigarette will be weakened as well.

Therefore, young smokers are more sensitive to the price change of cigarette. At the same time, Chalklike et al (2002) also explained that young smokers have shorter time of smoking and less addictive than elder smokers. 3. Apart from considering the impact on cigarette prices, what other factors would a policy maker have to keep in mind to predict the likely impact of a cigarette-tax hike on the consumption of cigarettes by the youth? The NEVER study has shown that hike on the cigarette tax results in large decline 14. 4% of youth smoker quit.

The reason is teenager are highly price sensitive and most f smokers start as teens, higher taxes can sharply deters smoking in the long run. In addition, a higher cigarette tax will hurt the tobacco industry and then affect the whole economy, because tax increase will lead to unemployment of tobacco company and manufacturing, as well as wholesale, retail. Therefore, the tax increase will have an adverse effect on the entire economy. Moreover, higher tobacco tax will increase tobacco smuggling and government will lose tax revenue. 4. Discuss the potential benefits and costs of increasing cigarette taxes.

Benefit: Save lives Cigarette smoking is the leading cause of preventable death and thousands of others suffer from related ailments that may unable to work or enjoy quality of life. According to the article, the Centers for Disease Control indicated that smoking kills about 443,000 people each year. The fact that nonsmoker will live longer and healthier. Output gains According to Reynolds American, the income for smoker in median household is about $20000 lower than nonsmoker. And other research shows that smokers are more trends to absenteeism from work than non-smokers.

As more people stop smoking, their output would increase due to reduced absenteeism. On the other hand, quit smoking also could reduced death rate, facts have proved people live longer seems they will have higher probability being in work until the average age of retirement . Thus, decreasing the amount of smokers also would result in output gain due to reduced mortality. Savings to the National Health Care Cost Smoking is associated with increased ill-health in the population and government needs to spend huge amount of money to treat sick smokers.

As more people top smoking, the risk of developing diseases will fall; these critical dollars could be used for other important needs in our nation. Raise national revenue Due to increase cigarette tax, government could generate much needed revenue to help necessities such as public education, health care, and public safety, and reduce the number of people, especially teenager, who smoke. That’s a win, win, win for the government. Cost: Higher tobacco taxes will hurt the poor since they smoke the most. Poor people have only few pleasures, and higher taxes will make tobacco unaffordable to them.

Tax increases on tobacco products will lead to increased smuggling, illegal cigarette production, and related criminal activity Higher tobacco taxes will not reduce tobacco use. Since tobacco addiction is very strong, for most adult smokers higher prices will not impact demand; therefore raising taxes is not useful. 5. How much importance do tobacco companies attach to economic analysis and concepts in shaping their strategy to counteract the effects of cigarette taxes? It is crucial for tobacco companies to analysis the situation and makes some price change to offset tax increase.

The article mentioned the young people decide the future success of tobacco companies; also the price is the most important factor of smoking behavior among youth. So, the tobacco companies are using increasingly sophisticated marketing strategies to circumvent the law and promote their brands to youth. For example, in order to offset the tax and keeping more smokers smoking, tobacco companies developed the marketing strategies include increase the price of more expensive brands over while decrease the price on the cheapest brands. Therefore, young people would not likely effect by the price increase. . Apply your knowledge of topic 2 to conceptualize the impact of the early adoption of the Bonsais cigarette machine by the American Tobacco Company on its production conditions, and how this facilitated the company’s rise to the dominant position in the industry in the late 1 9th century According to the researches of Chalklike et al (2002), the price elasticity of demand of cigarette in USA and other countries falls in the range of -0. 25 to -0. 5. This indicated that the when the price reduce by 10%, the overall cigarette smoking will raise by 2. 5 to 5%.

Therefore, lower price can lead higher amount f cigarette consumption. Bonsais cigarette machine is invented in 1880. Hand rolling of cigarettes moved to mass production. With this machine, American Tobacco Company can realize the large scale production. The productivity is improved. The direct impact is the production costs is reduced since it take less labor force and can work more hours per day. As mentioned above, price change has great influence on the consumption of cigarette. With the mass production and cost advantage, American Tobacco Company can set lower price and be competitive on the market.

Lower price with equivalent quality can increase the consumption of its cigarette. According to the data of Chalklike et al (2002), the cost is cut to half of the cost by hand rolling. If we assume that the price elasticity is -2. 5, and then the price also cut 50% according to the cost cut, then the consumption will increase by 12. 5%. With the cost advantage, American Tobacco Company can spend more on advertising and build brands, which in turn bring it more profits. With the pricing and advertising strategy, American Tobacco Company then dominate the industry in the late 19th century.

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