A Dynamic Simultaneous-Equations Model for Cigarette Consumption in the Western States

This paper presents a rational addiction model, which integrates the addictive behavior of smokers toward cigarette consumption and the dynamic, profitmaximizing behavior of an oligopoly of cigarette producers. This model is tested on a panel data for eleven western states over the period of 1967-1990, using simultaneous estimation techniques. The results suggest the following conclusions: first, cigarette consumption is price-sensitive, with a demand elasticity of about -.33 in the short run and -.44 in the long run. These elasticities are smaller than those reported in most previous studies. Second, our results at least partially confirm the theory of rational addiction. Third, our model of oligopoly behavior confirms the hypothesis that the tobacco companies often do, as a part of their oligopoly behavior, raise end-market prices by more than the amount of the tax. Fourth, our results indicate that antismoking ordinances matter in reducing cigarette consumption, though their estimated significance is marginal. Finally, our results indicate that a tax increase, such as that imposed in California as a result of Proposition 99 in January 1989, can have a strong effect on reducing cigarette consumption, ranging between 8 percent in the short run and 11 percent in the long run. * The authors are, respectively, Ph.D student in Agricultural and Resource Economics, Professor of Health Economics, and Professor of Economics at the University of California at Berkeley. This research was supported by funds provided by the Cigarette and Tobacco Surtax Fund of the State of California through the Tobacco-Related Disease Research Program of the Institute of Business and Economic Research at the University of California at Berkeley, Grant Number RT12. They acknowledge the helpful comments from Willard G. Manning and Paul G. Barnett.