According to an article in Forbes (March 2001) teen cigarette smoking declined signifi- cantly between 1975 and 2000. The most dramatic decline occurred in the years 1975-1981. Since then teen smoking has increased in some years and declined in others. Between 1975 and 1981 there was a slight decrease in the price of cigarettes. Thus the dra- matic decline in smoking is not attributable to an increase in cigarette prices. One theory is that the significant increase in gasoline prices over this period motivated many teens not to smoke.
a. Discuss how a rise in gasoline prices might affect the demand for cigarettes among teens.
b. Suppose there are two goods in the world, cigarettes and gasoline. Draw a figure that shows how an increase in gasoline prices can result in a decline in both gasoline and cigarette consumption. Use the standard consumer behavior graph with budget lines and indifference curves. Be sure to label your figure appropriately.
c. In the late 1990s the price of cigarettes increased from $2.50 per pack to $3.25 per pack. In one community during this time period, the number of packs of cigarettes consumed by teenagers fell from 10,000 to 9,000. Assume that everything except cigarette prices remained the same. Calculate the arc price elasticity among teens between these price points.
d. Calculate the total expenditures on cigarettes by the teens in part (c) both before and after the price increase. Did total revenue increase or fall? Discuss how this answer is implied by the arc elasticity that you calculated in part (c).