Refer to the “In the News” below: In his fiscal year (FY) 2015 budget proposal,

Question

Refer to the “In the News” below:

In his fiscal year (FY) 2015 budget proposal, President Obama envisions another hike in the federal excise tax on cigarettes. He engineered a tripling of the tax - from 39 cents to $1.01 per pack - in 2009. Now he wants to hike the tax by another 94 cents, to $1.95 per pack. It's easy to see why Obama (himself a smoker) likes the idea. The 2009 tax hike brought an extra $9 billion a year into the U.S. Treasury. It also reduced smoking and smoking-related health costs.

This time around, the Congressional Budget Office projects a 94 cent tax hike will increase federal revenue by $78 billion over ten years, helping to bring down project deficits. The CBO also projects that the higher price will reduce the number of smokers by 2.5 million and the number of smoking-related deaths by 18,000 over the same period.

Smokers don't like the idea at all, of course. Nor do the states, which will see their own tax revenues decline along with the cigarette sales. And convenience stores like 7-Eleven will see a big part of their profits go up in smoke.

If the price of a pack of cigarettes (including taxes) was $6 before the proposed 2015 tax hike was appoved,

(a) What was the price after the tax hike?

Instructions: Enter your response rounded to two decimal places.

$

(b) What was the (average) percentage increase in price?

Instructions: Enter your response rounded to one decimal place.

percent.

(c) If cigarette sales decline by 7.2 percent, what is the price elasticity of demand?

Instructions: Enter your response rounded to two decimal places.

In his fiscal year (FY) 2015 budget proposal, President Obama envisions another hike in the federal excise tax on cigarettes. He engineered a tripling of the tax - from 39 cents to $1.01 per pack - in 2009. Now he wants to hike the tax by another 94 cents, to $1.95 per pack. It's easy to see why Obama (himself a smoker) likes the idea. The 2009 tax hike brought an extra $9 billion a year into the U.S. Treasury. It also reduced smoking and smoking-related health costs.

This time around, the Congressional Budget Office projects a 94 cent tax hike will increase federal revenue by $78 billion over ten years, helping to bring down project deficits. The CBO also projects that the higher price will reduce the number of smokers by 2.5 million and the number of smoking-related deaths by 18,000 over the same period.

Smokers don't like the idea at all, of course. Nor do the states, which will see their own tax revenues decline along with the cigarette sales. And convenience stores like 7-Eleven will see a big part of their profits go up in smoke.

Explanation / Answer

(a)

In 2015, tax of 94 cents or $0.94 was proposed on cigarettes.

Price of a pack of cigarettes before tax hike = $6

Price after tax = $6 + $0.94 = $6.94

So,

The price after the tax hike was $6.94

(b)

Before the tax hike, price was $6 per pack.

After the tax hike, price is $6.94 per pack.

Calculate the percentage increase in price -

% increase in price = [($6.94 - $6)/$6] * 100 = 15.67%

Thus,

The percentage increase in price was 15.67%.

(c)

Percentage change (decrease) in cigarette sales = -7.2%

Percentage change (increase) in price of pack of cigarette = 15.67%

Calculate the price elasticity of demand -

Price elasticity of demand = % change in sales/% change in price = -7.2/15.67 = -0.46

The price elasticity of demand is -0.46.

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