Question

Assume the government receives more tax revenue when it raises taxes on cigarettes as part of the price of cigarettes. However, after five years, the government discovers that revenues from the cigarette tax have declined. This situation would be most likely to occur if
1) the demand for gasoline was perfectly inelastic in both the short run and the long run.
2) the demand for cigarettes was inelastic in the short run, but elastic in the long run.
3) the long-run elasticity of supply was much greater than the long-run elasticity of demand.
4) the long-run elasticity of demand was greater than the long-run elasticity of supply.

Answer 1

Answer:

2) the demand for cigarettes was inelastic in the short run, but elastic in the long run. 

Explanation:

Elasticity of demand measures the responsiveness of quantity demanded to changes in price.

Demand is inelastic if quantity demanded shows little or no sensitivity to changes in price.

Demand is elastic if a small change in price leads to a greater change in quantity demanded.

If the government taxes cigarettes, they become more expensive. In the short run, consumers do not have enough time to search for suitable substitutes for cigarettes. As a result, they continue purchasing the cigarettes despite the increase in price. Thus, demand is inelastic.

But over time, consumers would be able to find substitutes for cigarettes, as result they would reduce their demand for cigarettes. At this point demand is elastic. As a result of the fall in demand for cigarettes, the revenue the government earns from taxing cigarettes would fall.

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