The price for cigarettes sold by Big Tobacco Co Ltd was 6.00 per packet in March 2018. During the month of March, the consumption of cigarettes was 1000 packets. However, the Board of Directors of Big Tobacco Co Ltd decided to increase the price by 25% during the month of April. As a manager you noted that price elasticity of demand was 0.8. As a manager Big Tobacco Co Ltd:

A. As a manager Big Tobacco Co Ltd store advise your management of the strategy that could be adopted by your firm to maintain sales.

B. Also, advise your government on recommended interventions in the cigarette market.

Part A. Total sales under the 25% price increase strategy is higher so it must be opted.

Part B. Must intervene by imposing higher taxes on the cigarettes to control its consumption and our future generations.

Explanation:

By using the price elasticity of demand formula, we can calculate the quantity consumption by increasing price by 25%.

The formula is as under:

E = [(Q2 – Q1)  /  (Q1 + Q2) / 2]    /     [(P2 – P1)  /  (P1 + P2) / 2]

Here

Q1 = Consumption before price alteration = 1,000 Packets

Q2 = This is the amount we want to calculate = ?

P1 = It is the initial price which is $6 per packet

P2 = It is 125% of the initial price. So

P2 = P1 * 125% = $7.5 per unit

E = It is price elasticity of Demand which is given in the question and is 0.8. Remember that it is negative.

By putting the values in the Formula, we have:

-0.8 = [(Q2 – 1,000) / (1,000 + Q2) /2]    /    [(7.5 – 6) / {(6 + 7.5) / 2]

-0.8 = [(Q2 – 1,000) / (500 + 0.5Q2)]      /    [1.5 / 6.75]

-0.8 * (1.5 / 6.75) = (Q2 - 1,000) / (500 + 0.5Q2)

-0.1777 * (500 + 0.5Q2) = Q2 – 1,000

-88.85  - 0.1777Q2 = Q2 – 1,000

-0.08885Q2 – Q2 = - 1,000 +  88.85

-1.08885Q2 = - 911.15

Q2 = 911.15 / 1.08885      = 837 Packets

Part A.

We will assess which strategy generates higher sales. The strategy that generates higher sales will be adopted.

Sales under $6 per packet pricing:

Total revenue at $6 / packet = 1,000 Packets * $6 per packet = $6,000

Total revenue (TR) at 7.5 price = 837 Packets × $7.5 per packet = $6,277.5

As the total sales under the 25% price increase strategy is higher so it must be opted.

Part B.

The government must intervene by increasing the taxes on "injurious to health" products and intervene this way to decrease the consumption of cigarettes as it is not good for health. Higher prices of the cigarettes will act as an obstacle for smokers and as a result they will smoke less cigarettes. This is an ethically correct recommendation.

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