cigarrette addiction

7/28/2019 Cigarrette Addiction

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American Economic Association

An Empirical Analysis of Cigarette AddictionAuthor(s): Gary S. Becker, Michael Grossman and Kevin M. MurphyReviewed work(s):Source: The American Economic Review, Vol. 84, No. 3 (Jun., 1994), pp. 396-418Published by: American Economic AssociationStable URL: http://www.jstor.org/stable/2118059 .Accessed: 16/08/2012 09:39

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An Empirical Analysis of Cigarette Addiction

By GARY S. BECKER, MICHAEL GROSSMAN, AND KEVIN M. MURPHY*

To test a model of rational addiction, we examine whether ower past and futureprices for cigarettes aise current cigarette consumption. The empirical esultstend to support he implication f addictive behavior hat cross price effects arenegative and that long-run responses exceed short-run responses. Since thelong-run rice elasticity f demand s almost twice as large as the short-run riceelasticity, he long-run ncrease n tax revenue rom an increase n the federalexcise ax on cigarettes s considerably maller han the short-run ncrease. JELDll, D12, 110).

In Becker and Murphy 1988), a theoreti-cal model was developed in which utility-maximizing consumers may become "ad-dicted" to the consumption of a product,and the key empirical predictions were out-lined. In the Becker-Murphy rameworkconsumers are rational or farsighted n thesense that they anticipate the expected fu-ture consequences of their current actions.This paper uses that framework o analyzeempirically he demand for cigarettes. Thedata consist of per capita cigarette sales (in

packs) annually by state for the period

1955-1985. The empirical results indicatethat smoking s addictive.

The Becker-Murphy model follows HarlE. Ryder, Jr., and Geoffrey M. Heal (1973),George J. Stigler and Becker (1977), MarcelBoyer (1978, 1983), Frans Spinnewyn 1981),and Lawrence R. lannaccone (1986) by con-sidering the interaction of past and currentconsumption n a model with utility-maxi-mizing consumers. The main feature of thesemodels is that past consumption of somegoods influences their current consumption

by affecting the marginal utility of currentand future consumption. Greater past con-sumption of harmfully addictive goods suchas cigarettes stimulates current consump-tion by increasing the marginal utility ofcurrent consumption more than the presentvalue of the marginal harm from futureconsumption. Therefore, past consumptionis reinforcing or addictive goods.

This paper tests the model of rationaladdiction by considering the response ofcigarette consumption to a change in

cigarette prices. We examine whether lowerpast and future prices for cigarettes raisecurrent cigarette consumption. The empiri-cal results tend to support the implicationof addictive behavior hat cross price effectsare negative and that long-run responsesexceed short-run responses.

We find that a 10-percent permanent n-crease in the price of cigarettes reducescurrent consumption by 4 percent in theshort run and by 7.5 percent in the long run.In contrast, a 10-percent increase in price

* Becker: Department of Economics, University ofChicago, Chicago, IL 60637, and Hoover Institution;Grossman: Ph.D. Program n Economics, City Univer-sity of New York Graduate School, New York, NY10036, and NBER; Murphy: Graduate School of Busi-ness, University of Chicago, Chicago, IL 60637, andNBER. Funding or this research was supported by agrant from the Bradley Foundation o the Center forthe Study of the Economy and the State of the Univer-sity of Chicago. We are indebted o Eugene M. Lewit,David Merriman, hree anonymous referees, and theparticipants n seminars at the University of Chicago,Columbia University, Harvard University, he Univer-sity of Kentucky, he Federal Trade Commission, heCity University f New York Graduate School, ColgateUniversity, Pennsylvania tate University, nd the StateUniversity of New York at Albany for helpful com-ments and suggestions. We thank Frank Chaloupka,Brooks Pierce, Robert Tamura, Ahmet E. Kocagil,Geoffrey F. Joyce, Patricia De Vries, and Ismail Sirta-lan for research assistance. This paper has not under-gone the review accorded official NBER publications;in particular, t has not been submitted or approval bythe Board of Directors.

396


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VOL. 84 NO. 3 BECKER ETAL.: ANALYSIS OF CIGARETTE ADDICTION 397

for only one period decreases consumptionby only 3 percent. In addition, a one-periodprice increase of 10 percent decreasesconsumption n the previous period by ap-proximately .6 percent and decreases con-sumption in the subsequent period by 1.5percent. These estimates illustrate theimportance of the intertemporal link-ages in cigarette demand implied by ad-dictive behavior. We are not able to testother implications of the Becker-Murphymodel such as abrupt quitting behavior bycold turkey.

In myopic models of addictive behavior,past consumption stimulates current con-

sumption, but individuals gnore the futurewhen making consumption decisions. Weshow that these models imply that pastprices have negative effects on current con-sumption, but that they imply that there isno effect of anticipated future prices oncurrent consumption. Since rational modelsalways exhibit the symmetry of (com-pensated) cross price effects implied by op-timizing behavior, testing for the effects offuture prices on current consumption distin-guishes rational models of addiction from

myopic models. The results strongly rejectmyopic behavior, while they tend to supportthe model of rational addiction. However,some results cannot readily be explained byrational addiction.

The cigarette industry raised the price ofcigarettes in 1982 as well as in 1983 whenthe federal excise tax on cigarettes in-creased. The industry also raised cigaretteprices throughout he 1980's presumably nanticipation of a continuing all in smoking.Such pricing is inconsistent with perfectcompetition, but it is consistent withmonopoly power in the cigarette ndustry fcigarette smoking is addictive. Since otherevidence also suggests that the industry hasmonopoly power, this pricing policy is fur-ther testimony to the effect of addictivebehavior on aggregate cigarette consump-tion, because a monopolist will take accountof the effect of current price on the demandfor future consumption.

Our results are relevant to governmentregulation of the cigarette industry. Sincethe first Surgeon General's Report on

Smoking and Health in 1964, the federalgovernment and state governments havecarried out policies to increase publicknowledge about the harmful effects ofsmoking, o restrict advertising by cigarettemanufacturers, and to create no-smokingareas in public places and in the workplace.These policies will induce monopolistic pro-ducers to raise current prices because thedecline in future demand that they causereduces the gains from maintaining a lowerprice to stimulate future consumption. Thisindirect effect of the antismoking ampaignin the form of higher prices has not beentaken into account in evaluations of the

campaign e.g., Kenneth E. Warner, 1986).Our results also are relevant n estimatingthe potential revenue yield of an increase nthe federal excise tax rate on cigarettes tohelp finance national health-care reform orto reduce the federal deficit. Given the ad-dictive nature of smoking, consumption ofcigarettes is positively related to past con-sumption. For example, a price hike in 1993due to an increase in the federal excise taxrate would reduce consumption in 1993,which would cause consumption n 1994 and

in all future years to fall. Since we find thatthe long-run price elasticity s almost twiceas large as the short-run price elasticity, helong-run increase in tax revenue would beconsiderably maller than the short-run n-crease.

I. The Basic Model

Most empirical analyses of consumptiondeal with single-period models or assumetime-separable utility. By definition, single-period models cannot deal with the dynam-ics of consumption behavior, and the usualtwo-stage budgeting property of time-sep-arable models precludes any dynamics therthan those arising from dynamic wealthchanges and aggregate consumption effects.Since addictions mply inkages n consump-tion of the same good over time, it is es-sential to relax the additive-separabilityassumption n order to model consumptionof addictive goods.

The simplest way to relax the separabilityassumption s to allow utility n each period


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398 THE AMERICAN CONOMIC EVIEW JUNE 1994

to depend on consumption in that periodand consumption n the previous period. Inparticular, ollowing Boyer (1978, 1983), weconsider a model with two goods andcurrent-period tility in period t given by aconcave utility function

(1) U(YtCt,Ct-,,et) '

Here Ct is the quantity of cigarettes con-sumed in period t, Ct_ is the quantity ofcigarettes consumed in period t -1, Yt isthe consumption of a composite commodityin period t, and et reflects the impact ofunmeasured life-cycle variables on utility.

Individuals are assumed to be infinite-livedand to maximize the sum of lifetime utilitydiscounted at the rate r.

If the composite commodity, Y, is takenas numeraire, f the rate of interest is equalto the rate of time preference, and if theprice of cigarettes n period t is denoted byPt, then the consumer's problem s

QO

t-lu2) max JB (tt,Y,tt=1such that CO = Co and

00

Ea t-I(Yt+ PtCt)= AOt=1

where p = 1/(1 + r). We ignore any effectof C on earnings, and hence on the presentvalue of wealth (AO), and we also ignoreany effect of C on the length of life and allother types of uncertainty. The initial condi-tion for the consumer n period 1, C0, mea-sures the level of cigarette consumption nthe period prior to that under considera-tion.

The associated first-order onditions are

(3a) Uy(Ct,Ct-1,Yt,et)= A

(3b) Ul(tC ,Yt ,et)

+ OU2(Ct+I,Ct,Y,+I,et+1) = APt.

Equation 3a) is the usual condition hat themarginal utility of other consumption in

each period, Uy, equals the marginal utilityof wealth, A. Equation (3b) implies that themarginal utility of current cigarette con-sumption, U1, plus the discounted marginaleffect on next period's utility of today's con-sumption, U2, equals the current price mul-tiplied by the marginal utility of wealth. Inthe case of a harmfully addictive good suchas cigarettes, U2 is negative, although themodel that we develop simply assumes thatthis term is not zero. That is, the predic-tions contained n this section also are validin the case of beneficial addiction (U2 > 0).

Since with perfect certainty the marginalutility of wealth, A, is constant over time,

variations in the price of cigarettes overtime trace out marginal utility of wealth-constant demand curves or Y and C. In thetime-separable case, these demand curvesdepend only on the current price (Ps) andthe marginal utility of wealth, but with non-separable utility, they depend on prices inall periods through the effects of past andfuture prices on past and future consump-tion.

To illustrate, consider a utility functionthat is quadratic n Yt, Ct, and e,. By solving

the first-order condition for Y, and substi-tuting the result into the first-order con-dition for Ct, we get a linear differenceequation that determines current cigaretteconsumption as a function of past and fu-ture cigarette consumption, the currentprice of cigarettes, Pt, and the shift vari-ables et and et+1:

(4) Ct = OCt-1 + AOCt+1 O1Pt

+ 02et + 03et+1

where

UYYA01= u11u u) - U2

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