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

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.