Why do all brands of cigarettes cost the same?

Dear Cecil:

My friend, Nick O'Teen, has admitted that even if cigarettes were to go up to a $2.00 a pack, he would probably still buy them. I suspect many others would, too. But it occurs to me that even though a pack of puffers may vary in price from place to place, virtually every vendor uniformly prices the selection he carries (barring the differences between kings and 100s). Because of state cigarette taxes, federal subsidies, and parities, are these prices controlled by the government? Or is this some kind of smoke screen surrounding a major price-fixing condition? It seems to me that an enterprising tobacco company could blow rings around the competition by lowering prices designed to reach the consumer. Can you clear the air?

Cecil replies:

Ah, innocence. We clearly have need here of a basic economics lesson. In the cigarette biz, as in many other American industries, we have what is known as an oligopoly, where a few large firms dominate the market and by various more or less legal means contrive to keep the prices for all brands uniform. Demand for cigarettes in general is thought to be highly inelastic, meaning that people will buy about the same number no matter what the price is; but demand for individual brands is highly elastic–people are fickle, and will readily switch to another brand if it’s priced significantly lower. What this means is that if one manufacturer cuts his prices, he’ll sell a lot more cigarettes, but mainly at the expense of his competitors. Knowing this, the competitors would immediately have to drop their own prices, and the upshot is that everybody ends up selling about as many cigarettes as before, only at a lower profit margin. For this reason the manufacturers try to avoid price competition if at all possible. What usually happens is that one of the biggest companies emerges as the “price leader” (for many years it was R.J. Reynolds) and the other follow along with whatever price changes it decrees.

The Federal Trade Commission complains about such practices from time to time (or it used to, anyway), but to little effect. Most manufacturers of consumer products compete on price only when (a) introducing a new product, or (b) trying to drive a competitor out of business. In the cigarette racket, for example, predatory price-cutting was common around the turn of the century, when the Tobacco Trust, composed of the American Tobacco Company and several allied firms, cornered 95 percent of the market, typically by selling its products at a loss in a given area until local competitors went bankrupt or sold out. In 1911 the Supreme Court ordered the trust broken up into 16 successor companies (many of which are still around today). Since then the companies have mostly been content to compete on the basis of largely imaginary differences in quality, which they promote through extensive advertising. National ad campaigns are quite expensive, of course, which discourages new firms from entering the market, and as a result the existing manufacturers have the field pretty much to themselves.

This all sounds pretty snaky, I suppose, but it’s worth pointing out that oligopolies can’t just set any old price they want to. In 1931, for instance, all the major tobacco companies followed Reynolds’s lead in raising cigarette prices, despite the fact that the price of tobacco leaf had fallen to a 25-year low. This stupid move permitted several small manufacturers to introduce 10-cent brands to compete with existing brands, which were going for 13 cents a pack. By 1932, the 10-cent brands accounted for 23 percent of the market, setting off a price war in which wholesale prices were slashed 20 percent. Despite this, several relatively small companies, such as Philip Morris, were able to gain a foothold in the market and eventually overtook some of their previously impregnable competitors. Restores your faith in free enterprise, almost.

Send questions to Cecil via cecil@straightdope.com.

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