Examine the importance of the elasticity of demand in a government decision to impose a specific tax on the buyers of cigarettes
Price Elasticity of Demand is the responsiveness of a change in the quantity demanded of a certain good to a change in its price. The formula for Price Elasticity of Demand is the percentage change in the quantity demanded of a certain good divided by the percentage change in the price of that certain good (Alain Anderton, p.55). A specific tax is a tax that’s amount levied does not change with the value of a good but with the amount or volume of a good purchased (Alain Anderton, p74). Cigarettes are demerit goods which yield negative externalities. Demerit goods are goods that are overprovided by the price
…show more content…
If a specific tax is imposed on the buyers of cigarettes and they have an inelastic demand for them and the supply of cigarettes is fairly elastic then the incidence of the tax will fall largely on the consumer. This is illustrated below:
Figure 2 shows that in a free market the equilibrium price for cigarettes is 0P1 and quantity OQ1. However, the social optimum price is 0P2 and quantity 0Q2 where marginal social costs equal marginal social benefits of the last unit produced. The vertical distance CA represents the external cost for each cigarette consumed. By placing a tax equal to the external cost CA per cigarette, the government successfully internalises the externality. The total tax area is P2ACP3. The area P1P3CB represent the amount the producer pays towards the tax and the area P2P1BA represents the amount the consumer pays towards the tax. As illustrated, the incidence of the tax largely falls on the consumer because the demand for cigarettes is fairly inelastic and supply of cigarettes is fairly elastic. Hypothetically, if the demand for cigarettes was perfectly inelastic and the supply of cigarettes was perfectly elastic then the incidence of the tax would fall fully on the consumer.
Therefore, The importance of the Price Elasticity of Demand in a government decision to impose a specific tax on the buyers of cigarettes lies in the fact that the elasticity of
The elasticity of demand measures the buyer’s reaction to price as its changing. “Economists measure the degree to which demand is price elastic or inelastic with the coefficient E d, defined as E d = percentage change in quantity demanded of product X/ percentage change in price of product X” (McConnell, C. 2011). Therefore, Ed=∆Qd/∆Pd. When elasticity of demand is measured less than one, demand is considered to be inelastic. The coefficient in an inelastic range is less than one. When this takes place the percentage change in price is more than the percentage change in quantity. It can be said that when inelastic demand is present that quantity becomes less effected by price changing.
Specifically, they discuss the effects excise taxes, which is the tax paid by the seller. In this particular case, cigarette distributers are going to be affected by this Tabaco increase initiative. This article also contributes to a better understating of hidden taxes and the reasons behind tax changes. Joey corner also explains how the local or state government can be benefited through the collection of excise taxes.
Refer to Figure 6-23. The amount of the tax burden borne by producers is _____ per unit.
History has proven that government penalties, in the form of taxes, deter smoking. The 2000 U.S. Surgeon General’s Report, Reducing Tobacco Use, found that raising tobacco-product prices decreases the prevalence of tobacco use, and tobacco tax increases produce significant long-term improvements in health. From its review of existing research, the report concluded that raising tobacco taxes is one of the most effective tobacco prevention and control strategies (7). Along with price increases, mass-media campaigns and smoking bans have made cigarette smoking pretty much unacceptable in today’s society. “Today, approximately 22 percent of adults age twenty-two and older are smokers, compared with 33 percent in 1979” (Thorpe 1440). It is clear, from these examples, the use of penalties to deter the unhealthy behavior of smoking is a successful intervention.
For example, the tax incidences will change based on both the elasticity of demand and supply. The consumer has to
This project has three parts, namely Part 1, Part 2, and Part 3. Project Part 1 Introduction: Different economic studies estimate the price elasticity of demand for certain goods, some of which are reported on page 176 of the Hubbard/O’Brien textbook. The following table presents select elasticity of demand estimates from those reported on page 176. Product Barnes & Noble books Coca-Cola Cigarettes Beer Gasoline -4.00 -1.22 -0.25 -0.23 -0.06 Estimated Elasticity
As seen from both Figure 2 and Figure 3, the application of negative externality of consumption is appropriate, as it clearly indicates the before and after results of the implementation of the tax. As clearly shown, overconsumption leads to social inefficiency, but by applying a tax, a decrease in the consumption of plastic bags can allow for a shift of the market. The increase in social efficiency also allows for social cost and benefit to be equal. By applying taxes on the plastic bag negative externality it allows for a reduction in the supply of plastic bags. Due to this tax, the supply curve S1 will shift upwards to S2. This will inherently also reduce the gap between Qefficient and
Elasticity is a measure of the responsiveness of demand to changes in the price of a good or service. In the case of Steam Scot, when the price rises from 4 to 5, demand falls from 60,000 to 40,000 units. The original equilibrium market price of 4 pounds resulted in demand of 60,000 units and this generated revenue of 240,000 pounds. When the prices increased to 5 pounds the resulting demand is 40,000 units, and this generates total revenue of 200,000 pounds. When market price changes from 4 pounds to 5 pounds 40,000 pounds of revenue are lost in this indicates an elastic price elasticity of demand.
There are many cities who have implemented bans on cigarettes, but China overall is still the leading consumer of cigarettes in the world. A countrywide tax on cigarettes has been proposed to their Ministry of Finance, and Ministry of Economics and Trade, but a decision has yet to be made. Tobacco production provides substantial revenue to the government and a tax increase will have a significant effect on the central government and reduction of consumption of cigarettes. According to a study done by the group proposing the tax, “a 25% tax increase will have an overall monetary benefit that far exceeds the negative impact on the cigarette industry and tobacco farmers. In financial terms alone, not counting the number of lives saved and medical care cost savings, the gain of the central government tax revenue (24.58 billion Yuan) twice exceeds the loss of tobacco farmers’ earnings, tobacco industry workers’ earning and loss of industry and local government revenue (11.74 billion Yuan)” (Hu TW 107). There many components to this calculation, but some factors included the reduction of cigarette consumption, the number of lives saved, savings in medical care costs, gains in productivity due to avoidance of premature death, industry revenue lost, lost jobs in cigarette industry, loss of tobacco income, and loss of local government
A larger population, other things being equal, will mean a higher demand for cigarettes. Changes in the way the population is structured also influences demand. Many Eastern countries have a growing population and this leads to a change in the demand as there are more young adults in China (for example).Thus demand of cigarettes might increase
Changes to indirect taxes in particular can have an effect on the pattern of demand for goods and services. For example, the rising value of duty on cigarettes and alcohol is designed to cause a substitution effect among consumers and thereby reduce the demand for what are perceived as “de-merit goods”. In contrast, a government financial subsidy to producers has the effect of reducing their costs of production, lowering the market price and encouraging an expansion of demand.
Elasticity of demand helps the sales manager in fixing the price of his product, deciding the sales, pricing policies and optimal price for their products. The evaluation of this measure is a useful tool for firms in making decisions about pricing and production which will determine the total
Elasticity of demand represented as “Ed” is defined as a “measure of the response of a consumer to a change in price on the quantity demanded of a good” (McConnell, 2012). Determinants for elasticity of demand would include the substitutability of a good, proportion of a consumer 's income spent on a good, the nature of the necessity of a good and the time a purchase is under consideration by the consumer. Furthermore, elasticity of demand is calculated with this formula:
Recall that the elasticity of demand, which measures the responsiveness of demand to price, is given by