In the United States, many business firms in the cigarette industry joined with the government in a settlement of liability claims. Under the tentative agreement, the industry would curb advertising...

In the United States, many business firms in the 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 $.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 longterm, older, most-loyal (addicted?) customers. Do you agree? Explain carefully.

c) In the past, anti-smoking information campaigns have had some limited success in reducing smoking. What price reaction (if any) would the cigarette companies have to such programs? Explain carefully.