Cigarette Tax Hike Sparks Panic Buying - Essay Example

Running header: Running header: Patriotism Student’s name: Instructor’s name: Subject code: Date of submission: Economics Cigarette tax hike sparks panic buying The main issue presented in the report In the report, the Kelvin Rudd government is anticipated to increase the tax on cigarettes by an extra 25 percent which adds an extra $2.16 per cigarette packet. The government also aims at limiting internet advertising of cigarettes and spends $28.7 million on antismoking campaigns. The end result of these measures aimed at discouraging smoking is the collection of $5 billion in taxes which will be used in improvement of health services. In addition, it is expected that around 100,000 people will quit smoking while 25,000 children will not take up smoking as a result. However, the short run direct effect of the tax increase has been a sharp rise in demand for cigarettes as people anticipate the tax rise. The key stakeholders impacted by the tax increment Smokers – The smokers will be directly affected by the tax since they are the ones that consume cigarettes. The direct effect is that they will have to spend an extra $2.16 for a packet of cigarette. This will directly influence some of them to quit smoking especially among the low income earners as others reduce the number of cigarettes they smoke. In this regard, 100,000 people are expected to quit smoking. Potential smokers will also be affected by the increase. This will see about 25,000 children opting not to become smokers. The government – The additional tax will enable the government correct an extra 5 billion dollars in revenue (Fair, 2009). This will be used in improving health services in Australia and hence it will help in achieving the government’s policy on health. In addition, the government expects to succeed in its policy for quality health for its people by successfully reducing the number of people who smoke and those who join smoking. This can have a direct effect of reducing the budget used on treating smoking related diseases. The Business – The above measures are expected to negatively affect revenue from cigarettes. This means that the producers and sellers will have their revenues greatly decline due to those expected to either quit or reduce their smoking habit. In addition, the government’s crackdown on cigarette advertising is expected to reduce their revenues. Charities – the charities are expected to experience an increase in the number of people seeking assistance. This is because some addicts will want to be helped to quit smoking while those who don’t might have increased conflicts as they use more money on smoking at the expense of more pressing needs for instance feeding their families. What I believe will be the real impact of the issue I believe that the real impact of the tax increase will be the reduction of smokers within the country. Even those who continue smoking, they might be forced to reduce on their smoking habit. Furthermore, the high prices of cigarettes will discouraged many young people form joining in the habit. As such, I am of the opinion that business will be the most hit by the taxes. While the government and the smokers stand to gain from health improvement. The economic theories that can be drawn from the media report A number of economic theories can be drawn from this article. First, the government is seen as using its influence to discourage an undesirable habit. This is seen by way of affecting a 25% increase on cigarette taxes. This has the effect of increasing the price of cigarettes and hence discourages many from smoking on account of the increased prices and is inline with the government’s policy on health. The price elasticity of demand also comes into play in the article. First, by increasing the tax on cigarette and hence their prices, many young people are expected to quit the smoking habit while more potential smokers are expected to be discouraged from smoking in future hence showing the demand for cigarette to be elastic (Henry, 2003) . The supply side is also expected to react in the same manner. This is because the supplier will anticipate the demand to fall due to the increase in prices. As such, the suppliers will act accordingly by lowering their production as a result of the increased prices and hence the reduction in demand. Was the tax increase to be reversed or even reduced, the reverse would happen. The graph below shows the effect of the tax increase; The increase in taxes causes the price of cigarette to rise from Pe to P1 as shown in the graph. The customers respond to the increase in price by purchasing quantity Q1 as opposed to quantity Qe prior to the price increase. The tax charged on the cigarette is shown by the difference between P1 and Pe which is 50 percent of the cigarette price in this case. The supply side will also respond to the increased taxation in the long run. Due to the reduced demand, the supplier will have to adjust the quantity of production to a new equilibrium quantity. This is because the new tax measures and hence price increases will mean that smokers will demand less cigarettes (Andrew, 2007). As a result, the supply curve will shift to the left in response to government intervention or tax increment. The government act of market intervention creates a price floor and is shown in the graph below; 2. Levy may sting the borrowers not depositor What the main issue being discussed in the media report is; The article talks about the decision by Treasurer Chris Bowen to impose new savings account levy on the highly profitable banks and the effect this is likely to have on the market /business. The essence of introducing the new levy is to safeguard depositors of up to $250,000 in the unlikely event that the banks/financial institutions they have deposited their money become bankrupt. For this purpose to be achieved, the government aims at establishing a fund from the levy corrected from which any depositors who suffer loss when a bank/financial institution goes bankrupt can be compensated from. The levy is expected to raise up to $750 million in its first one and half years which will go towards the establishment of the fund (Gittins, 2013,). The banks however, are unhappy with the government’s decision to introduce the levy as it will eat into their profitability and hence they intend to pass the extra costs to the depositors. Whether this is possible or not is debatable due to the effect this is likely to have on the depositors’ willingness to deposit money and the financial institution demand for the deposits due to the need to source most of their funds from internal sources as opposed to relying on foreign sources. As such, the article argues that the banks may be eventually forced to shift the extra costs to borrowers rather than depositors due to the need to maintain the supply for deposits. Although the banks argue that they will shift the extra costs to the depositors without necessarily affecting the amount of deposits, this is not possible in reality. This is because many people might shy away from depositing citing the extra costs. This will result in the amounts of deposits declining and hence the bank will be forced to shoulder some of the extra cost while some of it is borne by the depositors. One way of doing this is by shouldering the costs which will eat into their profitability. To avoid this, the banks might be forced to shift some extra cost to borrowers and hence the new levy may actually end up hurting the borrower who might be forced to borrow at a higher rate .The depositor might actually only bear part of the cost with a larger portion being born by the borrower. However, if all costs are shifted to the depositor, this will have the effect of lowering the amount of deposits due to the extra cost. This will eventually reduce the resources available for lending and will end up having a negative effect on the banks profitability due to reduced resources and hence reduced borrowing. The key stakeholders that are impacted by the issue outlined in the report; The following are the key stakeholders that will be impacted by the issue outlined in the report in a number of ways:- a) The government – the government is the one that regulates the market according to the policies it wants to undertake. One of its policies is to protect the depositors in event that the banks go bankrupt as happened during the global financial crisis. As such, the government plans to introduce the levy which will be used to set up the compensation fund for depositors. In fact, the levy is expected to raise up to $750 million in its one and a half years of establishment. As such, the levy will help the government in achieving its policy objectives of depositor protection. In additional, the government will have additional revenue at its disposal. As such, the government stands to benefit from the new levy. b) The banking industry/business - The banking industry will be directly affected by the introduction of the levy. This is because whatever action they take in reaction to the levy might have an impact on their profitability. If they decide to shift the burden to the depositor, the supply for the deposits will most likely reduce owing as depositors react to the increased costs. On the other hand, if the levy is shifted to borrowers, the demand for funds may reduce incase the rates are increased substantially. An ideal situation is to share the increased costs between the depositors and borrowers where the borrower bears part of the levy just as the depositor. Alternatively, the banks might decide to shoulder the increased costs. This will still negatively affect their earnings. c) The depositors – the levy being introduced is aimed at safeguarding the depositors money through establishment of a compensation fund. As such, the depositors will have their deposits becoming more secure if the levy is actually introduced. However, a negative effect resulting from the introduction of the levy will be increased cost of depositing money with financial institutions especially if banks make good their threat to shift the extra costs to depositors. If this happens, we might see some decline in the amounts of deposits owing to the increased costs. However, due to the nature of the banking industry (oligopoly), this might actually not happen as each of the players try to win as much deposits as possible. d) The borrowers – although the levy is not intended for the amounts borrowed, the borrowers may be affected by it in the long run. This may arise from the decline in deposits expected and hence less funds will be available for borrowing. Alternatively, incase the banks decide to shift some of the extra costs resulting from the levy to borrowers, borrowing will become more expensive. This might negatively affect borrowers. What I believe the main impacts will be and who I believe will be impacted most. I believe that the overall impact of the new levy will be that of making banking services more expensive. This is because the most likely the banks and other financial institutions will opt to split the extra cost between depositors and borrowers. The reason for this is that shifting the entire cost to depositors might make deposits too expensive despite the high demand for them hence the need to still woo the depositors. As such, both the borrowers and depositors will have to pay more money for the services offered. However, I believe that the borrowers will be most affected by the new levy. This is because the levy is not aimed at the amounts borrowed yet the banks might decide to make borrowing more expensive in a bid to raise the required levy. Economic theories that can be drawn from this media report Supply after tax (S1) P3 P1 Tax Supply before tax (S0) P0 Q1 Q0 Quantity A number of economic theories are examined in the issue above. First, the effect of government intervention in the market is examined. The act by the government to introduce a levy on all deposits up to $250,000 is likely to increase the cost of banking services. If the banks shift the levy to the depositors, then deposits will be more expensive and this is likely to lead to a decline in the number of deposits made. The issue of elasticity of demand and supply is also examined in the article. The levy will most likely affect the demand and supply of deposits if all the cost is shifted to depositors. As shown in the graph above, the price of making deposits is expected to increase from P0 to P1 after the levy is introduced. This is hence expected to cause a reduction in the number of deposits made hence the shifting of supply curve from S0 to S1 as depositors react to the increment in deposit charges. The demand for the deposits is however expected to remain unaffected as banks need the deposits as internal source of fund. This being the case, it is highly unlikely that the banks will shift all the extra costs to depositors. The above graph shows that after introduction of the levy, the resultant equilibrium price and hence the new market price is lower than the amount of levy/tax imposed. The difference between the new equilibrium price and the tax effect is (p3-p2) implying that the depositors would have to pay a higher price P3 was the entire levy to be shifted to the depositors. This implies that some part of the levy has been shifted to the depositors while the banks will have to bear the other part leading to reduced profits. It is worth noting that this kind of scenario occurs in a perfect market and is an ideal situation (Russell, 2010). However, the banking sector is an oligopoly where each bank has considerable pricing power. Furthermore, the banks would obviously want to protect their profitability through shifting the extra costs more to the borrowers than to the depositors. This is due to the fact that the competition for deposits is high as banks strive to raise less funds through oversee sources and more from local deposits. This is the reason why the new levy might actually affect the borrowers more than the depositors. Other issues in the article that I believe to be relevant It is worth noting that the bank industry being an oligopoly implies that the threat to shift the entire burden to depositors might not work after all. This is because each bank has a considerable power over price control. Furthermore, the intensive competition for deposits means that any bank that takes an action that affects deposits will be losing its market to its competitors. Furthermore, the need to protect their profits will most likely see banks shifting the new burden resulting from the levy to borrowers. References: Fair, R2009, Principles of economics, London, Prentice Hall. Henry, S2003, The effects of price on alcohol and alcohol related problems, Alcohol Research and health. Andrew, G2007, Foundations of economics, Oxford, Oxford University Press. Russell, S2010, Microeconomics and behavior, London, Rutledge. Gittins, S2013, Levy may sting the borrower, not depositor, retrieved on 14th November, 2013, from; http://www.smh.com.au/business/levy-may-sting-the-borrower-not-depositor- 20130809-2rnbp.html Read More