U.S. cigarette makers face enormous punitive damage penalties after losing a series of class-action lawsuits that heaped penalties amounting to several hundred billion dollars on the tobacco industry. In spite of the huge penalties, The Wall Street Journal reported, "The damage (to cigarette makers) is generally under control." What action do you suppose the cigarette companies took to avoid bankruptcy? Why did this action succeed? Fully explain the answer to these questions using elasticity, demand, supply, and market equilibrium.
To understand how the cigarette companies avoided bankruptcy, let's analyze the situation using the concepts of elasticity, demand, supply, and market equilibrium.
1. Elasticity: Elasticity measures the responsiveness of demand or supply to a change in price. In the case of cigarettes, demand is considered relatively inelastic. This means that changes in price have a relatively small impact on the quantity demanded. Many people who smoke cigarettes are addicted to nicotine, making them less sensitive to price changes.
2. Demand and Supply: Despite the series of class-action lawsuits and the resulting penalties, the demand for cigarettes remained relatively stable. Over the years, the government and public health campaigns have implemented various measures to reduce smoking rates, including higher taxes, warning labels, and anti-smoking advertisements. However, these measures have had limited impact on reducing overall cigarette consumption.
3. Market Equilibrium: Market equilibrium occurs when the quantity demanded equals the quantity supplied at a particular price. In the case of cigarettes, the equilibrium price and quantity may have shifted due to the increased costs associated with the lawsuits, but the overall market still remained in equilibrium.
Now, let's address the action taken by cigarette companies to avoid bankruptcy:
1. Increase in Price: One possible action cigarette companies may have taken is to increase the price of cigarettes. Due to the inelastic demand for cigarettes, these companies may have been able to pass on a significant portion of the increased costs to consumers without experiencing a significant decrease in demand. By raising prices, the companies aimed to offset the financial burdens imposed by the massive penalty payments resulting from the class-action lawsuits.
2. Cost Reduction Measures: Cigarette makers might have implemented cost-cutting measures to mitigate the financial impact of the penalties. This could involve restructuring operations, reducing workforce, or finding more cost-effective production methods. By reducing costs, companies can maintain profitability despite adverse circumstances.
3. Diversification: Another strategy cigarette companies could have pursued is diversifying their product offerings. Recognizing the long-term decline in cigarette consumption, some tobacco companies have expanded their portfolios to include alternative products such as e-cigarettes or smokeless tobacco. By diversifying, these companies can tap into new markets or cater to changing consumer preferences.
In summary, the cigarette companies likely took several actions to avoid bankruptcy. These actions included increasing prices, implementing cost reduction measures, and diversifying their product offerings. Despite the enormous punitive damage penalties, the demand for cigarettes remained relatively stable due to the addictive nature of nicotine and the inelasticity of demand. This allowed the companies to continue operating while managing the financial impact of the lawsuits.