Economic Impact of Increasing Prices on Tobacco - Assignment Example

1. A higher tax on cigarette would mean that the cost of cigarette would increase. This would make certain section of the customer to either postpone their habit or to switch to some other cheaper mode like patches and gum. This will also translate into decreased sale of cigarette for different reasons and increase in the sale of other products. The effect of increase in the tax of cigarette will look as follows The above chart shows that increase in the tax rate would increase the price of cigarette which would increase the supply as suppliers will be willing to supply at a higher price but would lead towards a decrease in demand which would finally result in the quantity demand to fall. 2. The tax will have an effect on the price elasticity of demand for cigarette as a tax imposed would mean an increase in the price. If the tax is imposed on the supplier the supplier would look towards passing on the tax if not full partially to the customer. This will automatically result in the prices to move up. As a result of this the demand for cigarette will fall. The effect this will have on the price elasticity also supports the same as increase in prices reduces the demand which gets reflected through the price elasticity of demand which will be negative and confirm that the demand has decreased due to increase in price. This is shown through the diagram below The above chart shows that increase in the tax make the suppliers pass on the burden of additional tax to the consumers who as a result will have to pay more. This will have an effect as the consumers will be compensated as the suppliers won’t be willing to supply at the same price and only when the price moves up and covers the additional tax which has been imposed will be willing to do so. This will make the consumer bear extra pressure and have to bear the additional increase in the prices through taxes. 3. Price floor is the minimum price which has to be charged so that the suppliers are protected. This mechanism will work in this aspect as having a price floor which determines the minimum price the government can look towards reducing the consumption of cigarettes. This will require that the minimum price is kept high so that people who have a limited income don’t look towards consuming cigarette. Since, the minimum price of the cigarette is high it will automatically result in certain section of the society not consuming cigarette and will thereby result in a dip in the consumption as shown below The above chart shows that having a price floor at Pf will ensure that the prices of cigarette will automatically increase and will result in a decrease in consumption as with an increase in prices some section of the society will give up consumption of cigarette. This will thereby act as a mechanism through which the consumption is reduced without affecting the taxes but using a policy of price floor. 4. Perfect competition is a state where all producers sell similar products and the buyers are price takers as the market determines the price in the market. In case all the cigarette manufacturers start to sell identical products it will leave very little differentiation or no differentiation among the companies. This will ensure that people are able to move from one product to the other easily. The short run is shown below In the short run the number of firms is limited and the different companies are able to make a profit as shown above through economic profit. The campaign against cigarette will thereby reduce the demand for cigarette but since the number of firms are limited and few they will still continue to enjoy profits primarily due to the fact that the marginal cost of the firm will be lower than its marginal revenue. The situation will change in the long run as shown below In the long run the number of firms increases and the companies just make normal profits due to the high degree of competition which is prevalent. The campaign against cigarette will thereby reduce the demand for cigarette but since the number of firms is large they will start to incur losses primarily due to the fact that the marginal cost of the firm will be higher than its marginal revenue. The campaign against cigarette will thereby become effective and have an effect on the overall demand of cigarette. 5. The policy of applying taxes on cigarette will have an effect in the manner in which the demand and supply of cigarette will determine the equilibrium price and quantity in the market. This paper examines the manner in which the demand and supply of cigarette determines the equilibrium price and quantity especially when a tax is imposed on it. It also looks to present the demand and supply side factors which have a role in determining the demand and supply of cigarette. This thereby helps to understand the different factor which has relevance on the demand and supply of cigarette Considering a situation where there is no taxes on cigarette and the production of cigarette is high will result in an increase in supply and being demand the same made the supplier lower their prices so that they could sell off the extra production they had. This resulted in the price to fall and is shown through the following graph (Garg, 2010) The above graph clearly shows that the supply of cigarette has increased due to the fact that no taxes have been implied. This resulted in creating a gap between demand and supply which was matched by a decrease in price. The prices were further reduced on a continuous basis which ensured that certain section of the society who were unable to consume cigarette at a higher price was able to do so at a lower prices. This thereby helped the equilibrium to be achieved at a lower price but at a higher quantity. The consumption of cigarette gets affected when a tax is put on it as it has an effect on the overall price level. Since, the increase in taxes results in the price of cigarette to move up it gradually leads towards a decrease in consumption. Since, the demand for the product decreases had a decrease in supply of the cigarette due to increase in taxes results a change in the demand and supply in the market. This was due to the fact that taxes placed on cigarette mad it expensive and made certain section of the society stop consuming cigarette. This resulted in the price to rise and is shown through the following graph (Colell, Winston, Michael & Jerry, 1995) The above graph shows that when the consumption of cigarette decreased due to increase in taxes as it decreased the supply of cigarette. Since, demand didn’t fall in the same proportion as supply there was a gap between the two which made the suppliers increases the price to adjust the changes in taxes. To ensure that the sell of cigarette reduced which enabled certain section of the society who were consuming cigarette due at a low prices were unable to consume it at a higher price. This thereby helped the equilibrium to be achieved at a higher price but at a lower quantity (Mankiw, 2008). This shows that the demand for cigarette was largely affected by the different factors on the supply side. One of the main factors that affected the supply side was the changes in taxes which show that the production of cigarette was affected due to factors which determine the production of cigarette. The supply side is thereby affected which have an effect on the overall supply of cigarette (Docters, Schefers, Korman & Durman, 2008). In case of the demand side the demand for cigarette is constant and changes slightly as the demand for cigarette is consistent but varies with the changes in taxes. The fact that more and more consumers purchasing cigarette falls in the higher, middle and lower income bracket (Shepherd, 2006). The effect as a result on the demand is high as consumers having the purchasing power are still willing to pay for it but some certain section of the society give up the consumption of cigarette. Still the smaller segment of the lower income consumer who consume cigarette are affected by the price fluctuations and look towards postponing or changing the manner in which consumption pattern goes which has an effect on the demand of cigarette to a certain extent (Mayerhoefer & Zuvekas, 2008). Thus, the taxation policy on cigarette has an effect on the demand and supply of cigarette as certain section of the society stop consuming it and is a good mechanism which the government can use to control the demand of cigarette. This will also act as a method through which the government is able to reduce the consumption of cigarette ensures that the society becomes a better place. Refernces Colell, M., Winston, A., Michael, D. & Jerry, R. 1995. Microeconomic Theory. 3r Edition, New York, Oxford University Press, Pearson Education Docters, R., Schefers, B., Korman, T. & Durman, C. 2008. The neglected demand curve: how to build one and benefit. Journal of Business Strategy, Volume 25, issue 5, pp. 19-25 Garg, S. 2010. Microeconomics: Introductory. 7th edition, Dhanpat Rai Publication Mayerhoefer, C. & Zuvekas, S. 2008. The shape of demand: what does it tell us about direct to consumer marketing. The B.E. Journal of Economic Analysis & Policy, Volume 18, Issue 2, pp. 4-8 Mankiw, Y. 2008. The influence of monetary and fiscal policy on aggregated demand. Short Run economic function. The Times Magazine Shepherd, G. 2006. Vertical & Horizontal Shifts in demand curve. The Econometric Society, Volume 4, No. 4, pp. 361-367 Read More