A Dynamic Model of Rational Addiction: Evaluating Cigarette Taxes

This paper develops and estimates a dynamic model of cigarette consumption based on the theory of rational addiction. In the model, forward-looking consumers make smoking decisions to maximize their lifetime utility, considering the health consequences and the addictive nature of cigarettes. A key feature of our approach is to allow for rich consumer heterogeneity in preferences and the costs of smoking. We estimate the model using panel data on individuals’ smoking behavior. The parameter estimates confirm the key predictions of the rational addiction model, such as the importance of adjacent complementarity. We then use the estimated model to simulate the effects of different cigarette tax policies. The results show that tax increases can be effective in reducing smoking, but the long-run effects are significantly larger than the short-run effects. We also find that the welfare consequences of cigarette taxes vary substantially across different types of smokers.

Recommended citation: Gordon, B. R. & Sun, B. (2015). "A Dynamic Model of Rational Addiction: Evaluating Cigarette Taxes." Marketing Science. 34(3), 452-470.
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