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Suppose there is a bill to increase the tax on cigarettes by $1 per pack coupled with an income taxcut of $500. Suppose a person smokes an average of 500 packs of cigarettes per year—and wouldthus face a tax increase of about $500 per year from the cigarette tax at the person’s current level ofconsumption. The income tax measure would increase the person’s after-tax income by $500. Would the combined measures be likely to have any e�ect on the person’s consumption ofcigarettes? Why or why not? 91 words Permalink

Our ability as consumers to purchase goods and services is restricted by our budgets. Theincome available to us as well as the prices we must pay determines what to consume and howmuch. According to Rittenberg & Tregarthen (2009), a budget constraint limits spending, totalspending cannot exceed the budget available. So an increase in price or decrease in price maya�ect consumption as well as the rise and fall of income. Moreover, when we talk of an income-compensated price change we are referring to when the price of a good or service happen tochange and the consumer's income is adjusted so that they have enough to purchase theoriginal combination of goods and services at the new set of prices (Rittenberg & Tregarthen,2009). Looking at whether the combined measures will have any e�ect on the person's consumptionof cigarettes, the person was smoking an average of 500 packs of cigarettes per year before thetax hike. Buying that same quantity after the cigarette tax increase would cost an additional$500 ($1 times 500) per year. The income-compensated price change due to the tax increaserequires the person to take into account the $500 from the income tax cut and they can still buy500 packs per year (Rittenberg & Tregarthen, 2009). When the price of a product or serviceincreases, but the buyer's income stays the same, the substitution e�ect takes place(Investopedia, 2019). "The magnitude of the income e�ect of a price change depends on howresponsive the demand for a good is to a change in income and on how important the good isin a customer's budget" (Rittenberg & Tregarthen, 2009. pp. 179). Whether, the combinedmeasures have an e�ect on the person's consumption of cigarettes will also depend on howimportant the cigarettes are to them. If they are important then consumption will not bea�ected as the income tax cut will compensate for the price hike. If the cigarettes are not veryimportant to the

person and there may be substitutes, the consumption of cigarettes may bea�ected and it would decrease. References Investopedia (2019). Substitution e�ect. Retrieved fromhttps://www.investopedia.com/terms/s/substitution-e�ect.asp Rittenberg, L. & Tregarthen, T. (2009).Principles of Economics. Retrieved fromhttps://my.uopeople.edu/mod/page/view.php?id=227818...