Plain Sense Economics

This report on NBC News tonight highlighted the impact of a recent increase in Federal taxes on cigarettes and chewing tobacco.

The report mentions an estimate that a 10% rise in cigarette prices results in a 7% drop in smoking among youth and a 4% drop in smoking among adults.

There are a variety of studies on the price elasticity of demand for cigarettes, with varying estimates. The Surgeon General’s office issued a report summarizing the findings from a number of published studies. While the estimates differ some, the difference of elasticity between adults and youth smokers remains significant.

So, let’s review what price elasticity measures. The value of E is the ratio of the percent change in quantity demanded over the percent change in price. For a normal good, E should be negative – i.e. an increase in price yields a drop in quantity demanded, and a decrease in price yields an increase in quantity demanded. In either case one part of the ratio is negative, so the value of E is negative.

The figures reported by NBC (and many of the studies summarized by the Surgeon General’s office) show price elasticity for adults and children to be less than one. More accurately, the absolute value of E is less than 1.0. That means that quantity will change, percentage-wise, less than the change in price. OK – that makes sense. Smoking is understood to be addictive, and so we would expect that smokers might cut down on smoking as prices rise, but not by much.

What, then, is the explanation for youth smokers being “less inelastic”? Perhaps they are less addicted, since their experience with smoking is shorter. They also probably have less disposable income, and so even a modest price rise cuts into their budget more deeply. Are there other explanations?

By the way, the cigarette tax is an excise tax. Given the inelastic demand, we will expect only modest declines in smoking, but the government can expect to generate significant tax revenue.