Question 1:
On the basis of historical data, Richard Tennant has concluded, "The consumption of cigarettes is . . . [relatively] insensitive to changes in price. In contrast, the demand for individual brands is highly elastic in its response to price. In 1918, for example, Lucky Strike was sold for a short time at a higher retail price than Camel or Chesterfield and rapidly lost half its business."
a. Explain why the demand for a particular brand is more elastic than the demand for all cigarettes. If Lucky Strike raised its price by 1 percent in 1918, was the price elasticity of demand for its product greater than _2?
b. Do you think that the demand curve for cigarettes is the same now as it was in 1918? If not, describe in detail the factors that have shifted the demand curve and whether each has shifted it to the left or right.
Question 2:
The Schmidt Corporation estimates that its demand function is .Q _ 400 _ 3P _ 4I _ 0.6A where Q is the quantity demanded per month, P is the product's price (in dollars), I is per capita disposable income (in thousands of dollars), and A is the firm's advertising expenditures (in thousands of dollars per month). Population is assumed to be constant.
a. During the next decade, per capita disposable income is expected to increase by $5,000. What effect will this have on the firm's sales?
b. If Schmidt wants to raise its price enough to offset the effect of the increase in per capita disposable income, by how much must it raise its price?
c. If Schmidt raises its price by this amount, will it increase or decrease the price elasticity of demand? Explain. Make sure your answers reflect the fact that elasticity is a negative number.
Question 3:
According to S. Sackrin of the U.S. Department of Agriculture, the price elasticity of demand for cigarettes is between _0.3 and _0.4, and the income elasticity of demand is about 0.5.
a. Suppose the federal government, influenced by findings that link cigarettes and cancer, were to impose a tax on cigarettes that increased their price by 15 percent. What effect would this have on cigarette consumption?
b. Suppose a brokerage house advised you to buy cigarette stocks because if incomes were to rise by 50 percent in the next decade, cigarette sales would be bound to spurt enormously. What would be your reaction to this advice?