Cigarette Companies' Assessment - Assignment Example

Part A 1. Cigarette companies would benefit greatly from encouraging children towards smoking then in comparison to adolescents as it has been demonstrated that “80% of the habitual smokers take smoking at a juvenile age”. (Adams, 2009) The fact that young people have a high propensity to spend of goods like cigarette further gives a push. The companies by using this gimmick can ensure that the demand for cigarette rises and it will help them get smokers. The other fact that children who take up smoking are habitual smokers so the company will be benefitted greatly as it will help them get a customer for a long period of time. (Adams, 2009) 2. When a tax is imposed on cigarette it will raise the price of the cigarette as the consumers will have to pay more for the same cigarette. This will thereby have an effect on equilibrium quantity and price. The equilibrium price will increase due to increase in taxes which will lead towards a decrease in demand as price and demand moves in the opposite direction. It will look as follows In the above diagram we see that when the government levies an excise duty of $2 per cigarette box it gets reflected in the price as the price of cigarette increases by same proportion making the price to be 6 instead of 4. The increase in price makes the consumer spend more on the consumption of cigarette which thereby pushes certain section of the population to reduce their spending on cigarettes. This causes the demand to fall from Q1 to Q2 as seen above. 3. Increasing the taxes on cigarette will increase the government revenue in the short to medium run. (Tobacco Control, 2010) Raising the taxes in the short run will not have a much impact on the demand for cigarette as the demand is relatively inelastic. This will push down the consumption for demand to a certain extent but will not be much. It is seen that a rise in 1% of taxes will increase the government revenue by 0.6 to 0.9 percent. In the long run however the consumption will decrease much thereby reducing the effect the increase in taxes had on government revenues. However the government revenue is bound to grow and the proportion with which the government revenues grow due to imposition of taxes will depend upon the elasticity of demand for cigarettes. (Tobacco Control, 2010) 4. The imposition of tax law which differentiates smokers on the nature of age and the number of cigarette smoked will be of little help for the government. One of the major reason for this is that the demand for cigarette is relatively inelastic so a imposition of tax will have little effect. Further having different rates will make minors use different ways to procure cigarette. For example the minor might use someone who is more aged to purchase the cigarette instead of purchasing himself. This will save the minor from paying extra. On the whole the process will help to a certain extent and reduce smoking to a certain extent but the magnitude of influence due to tax law will be little. 5. In the long run the effect of tax will slowly wipe out as decrease in demand will make the manufacturer produce fewer cigarettes. This will eventually push the price slightly and a equilibrium price and demand will be achieved at a different point. For example continuing with the pervious example where the taxes pushed the price to 8 will eventually turn around to 7 and the aggregate demand will be in between Q1 and Q2. This will also have an effect on the government taxes as it will reduce due to reduction in production. Thus the equilibrium will be achieved but it will be at a lower point as shown below The above diagram shows that in the long run the price is between 4 and 6 and the quantity is between Q1 and Q2. Thus the aggregate demand, price and government collection due to taxes gets affected though it gets influenced due to the elasticity of demand for cigarette. 6. Having a quota on cigarette will help to reduce consumption as the demand will be more than supply. This will result in the prices of cigarette to be set above the equilibrium price. It will create a gap between demand and supply. Since the price is more but imposition of quota won’t increase supply. Consumers are not willing to purchase at this point as they have to pay more. This will ensure that certain sections of the consumer who use to smoke are not able to purchase the same given the constraints of income. This will thereby drive the demand for cigarettes down and will help to reduce smoking. (Boyes & Melvin, 2008) But on the other hand this will lead towards black marketing and certain section of the population who are able to pay will continue smoking. Doing so will be going against the free market but will definitely help to curb smoking. 7. The smoking regime in Australia is very strict as there is a ban on smoking commonwealth buildings, trains, public places, buses and airports. Further each state has their own law regarding the same. Special stress has been laid to ensure that smoking is banned in public places and restaurants. (Smoke free laws, 2011) Different societies and the government is working to ensure that the people consuming reduces and the burden for the same is borne by the cigarette companies as they will have to lose vital revenues which could otherwise be earned. The article proposes that the burden to be shifted to the consumers who smoke cigarette. The article further substantiates that the burden be borne on the basis of age and consumption frequency. This will help and provide an incentive as it will help to reduce smoking. 8. Free market is a situation where the markets reacts by itself and the equilibrium quantity demanded and supplied is determined with little or no government efforts. (Free Market, 2011) Markets are said to be efficient when there is no government control and are said to achieve equilibrium themselves as seen below It is important to not here that the market forces act by themselves to bring equilibrium. This happens in case of goods which are not harmful or destructive by nature. This makes it important that government intervenes so that harmful activities like smoking are taken care of. Having government intervention in terms of cigarette will help to ensure that government takes steps like raising taxes, quota and other measures which puts a binding on these harmful activities. This will apart from reducing smoking will help the society as it will help to reduce early deaths, exposure to second hand smoking, and disease sue to passive smoking. Intervention by government will help to ensure that steps are taken in the correct direction which helps to protect the society. Though free market is consider as an efficient allocator of resources but in situations where harmful activities take place it is important to have government intervention to ensure well being of the society. Part 2 1. Monopolistic is a form of market structure where there are many sellers selling similar product. There are many manufacturers of cigarette. This leaves the company with very little to alter the price. Thus the prices are very similar and there is not much difference. This makes them more of a “price taker”. (Miller, 2008) “The products produced are more or less similar” (Miller, 2008). Every manufacturer has cigarettes in all segments. Their cigarettes are also very similar with very little difference to choose from. Thus, customers have a choice to make. The information with the customer regarding the prices of cigarettes is there. In case there is difference then the customer has a choice to pick other. As there is complete information it creates healthy feeling among the consumers. There is also complete information regarding the way the cigarettes are manufactured and the technology used. There is freedom of companies to enter and exit the market. There are certain norms of the local government which the company has to adhere to and it is similar as every country has so but there is no legal barrier. This helps the company to decide its future course as there is freedom for both. Here also cigarettes manufactures try selling their cigarettes which will fetch them maximum profits. “This is when the marginal revenue = marginal cost” (Miller, 2008). Since, there is so much competition this situation is also there. This is also seen in the diagram below. It can be seen that price is determined where supply matches demand for the market. Figure 1: Optimization of profit $ MC $ S ATC P AVC D Thus the cigarettes market has lots of companies where the equilibrium is determined by the market forces thereby giving rise to welfare benefits both to the consumer and the producer as both of them get the correct return thereby enabling the producers and consumers to ensure equilibrium as seen below Price S D Quantity This is evident from the above diagram where equilibrium is achieved by the market forces thereby determining the equilibrium quantity and price. 2. In the long run a cigarette manufacturer incurring losses cannot continue its operations as all factors of the production are variable. There is no fixed factor of production. So, if a cigarette manufacturer continues operations while it is not able to cover its variable cost would mean loss for the business and will require to be shut down. This will thereby force certain players get out of the market. This will help the producer as when certain manufacturer shut down operation then the other cigarette manufacturer can raise the price as the demand is more thereby enabling them to earn zero economic profits and earn normal profit. This will thereby have an effect on the number of firms operating in the market and will bring a change in the market structure. But if the prices start to rise and firms are able to earn super normal profits then more firms will enter the market. This will thus have little effect on the actual market structure as in the long run the decrease in firms selling cigarette will be distributed evenly thereby leaving little difference to differentiate the market structure with the actual market structure. 3. In case of two manufacturers of cigarettes there exists a duopoly. When these firms collude and agree to do a transaction once then the strategy of each player gets reflected in the payoff. (NCAA, 2010) The players collude either for a price, marketing strategy or other mechanism which benefits both the producers. In the situation when the players play once then the players have to take a decision which results in a payoff. The payoff decision depends on the decision taken by its rival. This creates a dilemma as the players look towards replicating the strategy of the other players. To ensure equilibrium in the cigarette industry it is important that the two players agree into an agreement and take similar strategy so that the benefits and looses for both the players remains the same. The problem is that in case one player changes the strategy then the other player has to compensate and since the game is played only once so equilibrium is achieved as long as both the players continue similarly. In case the game is played more than once then it provides opportunity for both the player to change their strategy and match those of the competitor. It provides advantage to the cigarette company as they can bring about change in the strategy which will help them to achieve equilibrium time and again. This will help both the players as they will be able to mould their strategies time and again which reap them maximum benefits and helps to achieve equilibrium. References Adams M, (2009), “Preventing Children’s Tobacco Consumption”, The Economist Voice, The Berkeley Electronic Press Boyes W & Melvin M, (2008), “Macro economics”, 7th edition, Houghton Mifflin Company Free Market, (2011), “What does free market mean”, retrieved on January 11, 2011 from http://www.investopedia.com/terms/f/freemarket.asp Miller J, (2008), “Principles of micro economics”, Tata McGraw Hill, India NCAA, (2010), “Oligopoly: Competition among a few”, Prentice Hall Smoke free laws, (2011), “Smoke free laws: Australian States and the World” retrieved on January 19, 2011 from http://www.ashaust.org.au/SF%2703/law.htm Tobacco Control, (2010), “The cost and consequences of tobacco control”, Chapter 6, The World Bank Group Read More