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Public Policy and Market Competition: How the Master Settlement Agreement Changed the Cigarette Industry

Ciliberto, Federico and Kuminoff, Nicolai (2010): Public Policy and Market Competition: How the Master Settlement Agreement Changed the Cigarette Industry. Published in: The B.E. Journal of Economic Analysis & Policy [Frontiers] , Vol. 10, No. 1 (17 July 2010)

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Abstract

This paper investigates the large and unexpected increase in cigarette prices that followed the 1997 Master Settlement Agreement (MSA). We integrate key features of rational addiction theory into a discrete-choice model of the demand for a differentiated product. We find that following the MSA firms set prices on a more elastic region of their demand curves. Using these estimates, we predict prices that would be charged under a variety of industry structures and pricing rules. Under the assumptions of firms’ perfect foresight and constant marginal costs, we fail to reject the hypothesis that firms collude on a dynamic pricing strategy.

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