Recently, the Major Firms in the United States Cigarette Industry

question 7

Essay

Recently, the major firms in the United States cigarette industry joined with the government in a settlement of liability claims. Under the tentative agreement, the industry would curb advertising and pay the equivalent of about $15 billion per year (for smoking-related state Medicaid expenses) in exchange for protection against smoker lawsuits.
(a) Before the settlement, a leading cigarette manufacturer estimated its marginal cost at $1.00 per pack and its elasticity of demand at -2. What is its optimal price? The firm's share of the industry payment (based on its historic market share) will raise its average total cost per pack by $0.60. What effect will this have on its optimal price?
(b) A marketing manager suggests that the firm should offer price discounts to the company’s long-term, older, most-loyal (addicted) customers. Do you agree? Explain carefully.
(c) In the past, anti-smoking information campaigns were fairly successful in reducing smoking. What price reaction (if any) would the cigarette companies have to such programs? Explain carefully.

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