Cigarettes and Smokers Regarding The Economy - Essay Example

?Q1. Externalities occur when there are differences between marginal private costs/benefits and marginal social costs/benefits. If there is a negative externality attached to any good then that means that the cost to society (MSB) is greater than the cost (MPC) the consumer is paying for it (http://www.economics.fundamentalfinance.com) .The price that a consumer pays for a packet of cigarettes is the private cost that he incurs but in the case of cigarettes private cost is exceeded by social cost for reasons such as passive smokers are at a greater health hazard than active ones, smoking results in ulcers and different kinds of cancer such as lung cancer, mouth cancer etc. In the figure below, the triangle E1EF represents the welfare loss to the society. Q2. The elasticity of demand for cigarettes is inelastic for adults which mean that demand is not that responsive to a change in price (Kamin). How much the incidence or burden of sales tax is borne by consumers and how much is borne by producers depends on elasticity of demand and supply. An important concept to bear in mind is that sales tax is a tax on a transaction as opposed to a tax on a person. For instance if a packet of cigarettes currently costs $2.50 and there is a sales tax of $1 on it, then the producer will not be willing to sell it at any price less than $3.50. The diagram below shows how the tax burden will be distributed: As can be seen from the graph above, the decrease in consumer surplus is a lot greater than the decrease in producer surplus as the elasticity of demand for cigarettes is inelastic and the supply is elastic. The consumer bears greater burden of the tax. There is also a dead weight loss (area represented by the triangle) as the difference between Qt and Q* represents the goods unsold because of the imposition of tax. The benefit of selling these goods is not large enough to cover the tax burden so the sale of these goods does not take place. Dead weight loss is of benefit to neither the producer nor the consumer. However if the supply and demand for cigarettes were both unitary elastic, then the burden of tax would have been shared equally by the producer and the consumer. The diagram below shows the equal reduction in consumer and producer surpluses: Q3. A price floor is a form of government intervention to prevent decreases in price. Governments use a price floor to discourage the consumption of some goods for example cigarettes. Smoking is the leading cause of cancer in Australia hence the Cancer Council of Australia requested the government to abolish duty free tobacco sales and to set a price floor in order to stop the sale of cheap cigarettes that pose a serious threat to public health. The diagram below shows what a price floor looks like. P0 is the equilibrium price where the quantity demanded (q d ) equals the quantity supplied (q s ). However at the price P*, q s is greater than q d indicating a surplus in the market at the price floor and a loss in sales revenue. Q4. If the suppliers earn positive economic profits, then this will attract new entrants into the perfectly competitive market because of free entry and exit (College). Also because the cigarettes are identical, new entrants do not have to worry about advertising. The overall industry output will increase which will cause a rightward shift in the industry’s supply curve (from S to S1). This will apply a downward pressure on price as the quantity supplied is greater than the quantity demanded and there is a surplus (Q1-Q3) in the market. The price will drop till the point where an individual supplier is only able to earn normal profit (the point where average revenue equals average cost). Hence the opportunities of positive economic profits are diminished in the long run. If the government’s antismoking campaign proves to be successful, then that means people become more aware of the hazards of smoking. This can lead to a fall in the demand for cigarettes because demand in a perfectly competitive market is infinitely elastic. People who are casual smokers might even quit completely as they do not have addiction issues. The industry’s demand curve will shift rightwards from D1 to D2, resulting in a change in price from P1 to P2 and in equilibrium quantity from Q1 to Q2. The individual firm’s sales revenue is measured by “prices times’ quantity (P x Q)”. It is clear from the diagram (Bamford 166)below that the area P1Q1 is greater than the area P2Q2, indicating a fall in the individual firm’s revenue, though the firm is still able to earn a positive economic profit. Q5. Cigarette is a legal good but its harmful effects surpass the pleasure it gives. Take Ukraine for example, which has 16.5 million smokers and there are 115,000 deaths per year because of tobacco related diseases and the male life expectancy is also very low (Samina Shariff 1). As per the theory of Pigouvian taxation: “taxes on a product should be set equal to the externalities the product’s use imposes on others and should not depend on effects on oneself (which are assumed to be internalized in consumption decisions)” (Koszegi). Imposing higher sales taxes on cigarettes is a consequence of higher externalities posed by cigarettes to the society and this policy also is in synchronization with the theory of Pigouvian taxation. In the Ukraine example, if the sales tax was increased to 70%, tobacco related deaths between 249,000 and 994,000 could be avoided (Shariff 1). Cigarettes taxes are most effective in reducing consumption of the young population or more precisely children and teenagers who get pocket money and are not financially independent (Chaloupka). People who try cigarettes for thrill will be put off greatly by a significant amount of sales tax. But for hard-core consumers of cigarettes, quitting is not easy at all as they experience withdrawal symptoms if they try to quit. They will be willing to forgo their consumption of other products but cigarette. Foregoing the consumption of other products does not curb the need for them. Therefore, hard-core smokers tend to resort to shop lifting because after spending on cigarettes they are left with very less money. The sellers of other products will incur losses because hardcore smokers are willing to sacrifice products like biscuits, sweets, chocolates or magazines for cigarettes. Sometimes when the government announces a rise in sales tax on cigarettes, it takes time for the tax to come into effect. In the mean while smokers buy cigarettes in bulk so that they do not have to pay the higher price for a packet of cigarettes. So this bulk buying should be taken into account before the government imposes sales tax. Some economists are of the view that a sales tax on cigarette will be more effective in the long run than in the short run because smokers readily adjust to price in the short run. If the price is permanently increased from let’s say $2.5 to $5.0 for a packet of cigarettes then the long run impact will be double the short run one and a lot of people will be able to overcome the habit altogether. Imposing a sales tax on cigarettes is just not enough. The revenue generated from sales tax should be invested in Health Programs dedicated to discouraging smoking. Also filtered cigarettes should be taxed less than the unfiltered ones. However the difference in the tax rates for the two should not be very large. Besides this taxation policy, there should be a ban on cigarette advertising and it should be made mandatory that the hazards of smoking be mentioned on a packet of cigarettes. With no advertising, the attractive packaging also lures consumers. The government should come up with a generic packaging design that is less appealing to consumers. It should be obligatory on retailers to sell cigarettes to people who have attained the age of majority (18 years old). Government sponsored campus drives at different schools and universities should be held in which lectures on negative effects of smoking should be conducted. Student volunteers can also be hired by the government to spread awareness. There should be tariffs imposed on the cheap cigarettes imported from other countries. Sales taxation alone cannot deter consumers from smoking. Like other economic policies, taxation should be carried out with above mentioned measures to ensure good health of all. Works Cited Bamford, Colin. AS Level and A Level Economic. Cambridge University Press, 2002. Chaloupka, F J. tobaccocontrol.bmj.com. College, Geoff Riley of Eton. http://wwwtutor2u.net. September 2006. . http://www.economics.fundamentalfinance.com. . Kamin, David. www.swarthmore.edu. 2002. . Koszegi, Jonathan Gruber and Botond. "A Modern Economic view of Tobacco Taxation." 2008. Samina Shariff, Anna Gillmore and Hana Zaubova Ross. "Economics of Tobacco Taxation in Ukraine." 2009. Shariff, Samina. "Economics of Tobacco Taxation in Ukraine." 2009. Read More