Answer:
Government should increase the price from $2 to $3.
Explanation:
Price elasticity of demand is calculated by dividing percentage change in quantity demanded by the percentage change in price.
Therefore:
Price elasticity of demand = [tex]\frac{percentage change in quantity demanded}{percentage change in price}[/tex]
From the question, we see that the price elasticity of demand for cigarettes is about 0.4.
Percentage reduction in quantity demanded = 20%
Percentage reduction in price = x
We calculate thus:
0.4 = 20/x
0.4x = 20
x = 20/0.4
x = 50
Percentage reduction in price is therefore 50%
This means that government should increase the price from $2 to $3.
