What the graph will show for 1999 depends on how
much of the price increase of late 1998 reaches the consumer
and how quickly the price increase hits. If the inflation-
adjusted price moves up toward $1.40, consumption may be
below 450 billion pieces and off the graph in Figure 2. A big
part of that decline will be because young men and women
do not start to smoke, given the now higher prices. A 20
percent price increase would bring a 26 percent reduction in
smoking if the -1.3 elasticity still holds. Twenty-six percent
is a large effect and suggests that the U.S. tobacco market
will, in fact, be impacted in a very significant way by the
price increase announced by the tobacco companies.
Some cautions need to be applied in using this finding.
Perhaps the most significant is the fact that a 20 percent,
one-time increase in price will move the price level outside
the range of data from which the elasticity estimate was
generated. Extrapolating and using statistical measures
outside of the range of data employed in the estimation
process is always dangerous. But even given due
consideration to this caution, this price increase will have a
major impact on smoking, especially by young smokers. Such
a reduction is consistent with the observation by a number of
national policy analysts who have argued that a substantial
increase in the federal excise tax on cigarettes would increase
prices and significantly curtail tobacco usage. In recent years,
increases as high as $1.50 per pack have been discussed,
with the possibility of a $.50 per pack increase in federal
excise tax being accepted as more realistic by most observers.
That tax increase discussion has essentially disappeared, but
the basic issue of increased price remains. In this current
instance, a per pack price increase, almost as large as the
discussed $.50 per pack federal excise tax, is coming from
the tobacco companies seeking ways to finance the settlement.
The pricing strategy by the companies may be a very
practical one. When looking at the entire smoking community
in the United State, most researchers estimate the price
elasticity of demand in the neighborhood of -.4 to -.5
(Chaloupka and Grossman). Using an elasticity of demand
of -.45 and increasing the price of cigarettes by 20 percent
could actually increase total revenue to the firms selling the
cigarettes. Revenues increase because, in the inelastic portion
of the demand curve, the increase in price is substantially
larger in percentage terms than the accompanying percentage
decrease in quantity consumed. That result also fits most
observers’ intuition that people who smoke will tend to
continue to smoke, often irrespective of price, and that price
will not have a large impact on consumption of habitual
smokers. Thus, selling a smaller quantity of cigarettes
domestically could raise total revenue to the tobacco
companies. What happens to their total costs and to their
profits is somewhat of an unknown. Companies would buy
and employ less of the raw tobacco that goes into the finished
product, but tobacco costs are only 2 to 3 cents of total per
pack costs. Per pack costs would be increasing since other
costs, especially fixed costs (equipment, buildings, taxes,
insurance, even some personnel costs), would be spread
across a smaller volume of operation. But the announced
higher prices will not necessarily destroy manufacturers’
profit positions.
Higher prices do not mean manufacturers will be less
profitable. Total dollars from cigarette sales are likely to
increase because of the inelastic demand for cigarettes.
These observations document the importance of looking
at pricing policies of the cigarette companies when evaluating
the consumption of tobacco. Any policy consideration that
involves concern about health costs and usage of a product
that is allegedly addictive has to take into consideration the
price at which the product is being offered to the consuming
public. Clearly, pricing policies can enhance usage. The
pricing decisions of the early 1990s, when the companies
significantly reduced the price of name-brand cigarettes,
showed the use of lower prices to encourage consumption.
Some felt that this one, significant reduction in cigarette prices
more than offset all of the educational programs and increased
monitoring of retail outlets being used to discourage young
people from starting to smoke. The question of whether the
price decrease did, in fact, neutralize the youth smoking
prevention programs cannot be answered without looking
empirically at what happened. But even a qualitative and
largely descriptive appraisal of the situation confirms pricing
policies are very important when considering tobacco usage
and attitude of society toward it.
The Future of the Tobacco Producer
The analytical framework also has something very
important to say about the future of producers. The large
-1.3 elasticity for young smokers suggests the already-
announced price increases by the companies will have a huge
impact on future consumption in the U.S. domestic market.
High prices keep many young men and women from starting
to smoke, and the survey data show people do not usually
start smoking after age 21. Unless this decrease in domestic