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Unformatted text preview: Eco 1 Spring 2008 Problem Set 4 Answer Key 1) According to a study by the federal Centers for Disease Control and Prevention, the price elasticity of demand for cigarettes is -0.25. Americans purchase about 480 billion cigarettes each year. a. If the federal tax on cigarettes were increased enough to raise the price of cigarettes by 50%, what would be the effect on the quantity of cigarettes demanded? If price elasticity of demand = -0.25, then a 1% increase in price will generate a 0.25% decrease in quantity demanded. Therefore a 50% increase in price will cause a 12.5% decrease in quantity demanded. b. Is raising the tax on cigarettes a more effective way to reduce smoking if the demand for cigarettes is elastic or if it is inelastic? Explain. Elastic demand is more responsive to price than inelastic demand. Therefore the policy is more effective when demand is elastic (it is not). 2) Use the following table It was probably not obvious that this referred to price changes in the first, and demand quantity changes in the second I forgot to write that in. Good Cross-price elasticity of demand Air-conditioning units and Kilowatts of electricity -0.34 Coke and Pepsi +0.63 SUVs and petrol -0.28 McDonalds food and Burger Kings food +0.82 Butter and margarine +1.54 a) Explain the sign of each cross-price elasticity in the table above. What do they suggest about the relationship between the two goods? suggest about the relationship between the two goods?...
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