U.S. cigarette makers face enormous punitive damage penalties after losing a series of class-action lawsuits that heaped penalties amounting to several hundred billion dollars on the tobacco industry. In spite of the huge penalties, The Wall Street Journal reported, "The damage (to cigarette makers) is generally under control." What action do you suppose the cigarette companies took to avoid bankruptcy? Why did this action succeed? Fully explain the answer to these questions using elasticity, demand, supply, and market equilibrium. Respond to at least two of your fellow students’ postings.
In order to recover lost revenue and avoid bankruptcy, the cigarette companies raised the price of cigarettes quite considerably. They put the loss back on the consumer. With cigarettes being an addictive product, consumers couldn’t and wouldn’t simply give up the habit based on the steep price hike. Price elasticity of demand “measures the responsiveness or sensitivity of consumers to changes in the price of a good or service” (Thomas, 2011, p. 205); thus, the unwillingness of smokers to quit buying cigarettes determines their inelasticity. When a change in price causes consumers to respond so weakly that the percentage by which they adjust their consumption is less than the percentage change in price, demand is said to be inelastic over that price interval (Thomas, 2011, p. 206). Moreover, “the availability of substitutes is by far the most important determinant of price elasticity of demand” (Thomas, 2011, p. 211). Therefore, the better the substitute for a good or service, the more elastic the demand for that good or service, and vice versa. So, when the price of a good rises, demand will fall, especially if consumers perceive that a close substitute is available. However, with cigarettes not having a close substitute, consumers are, unfortunately, less responsive to the price hike.
Thomas, C. R. (2011). Managerial Economics foudations fo business...
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