How The Cigarette Industry Affects Society With Disease And Reduces Social Economic Welfare

1142 Words Jan 8th, 2015 5 Pages
The cigarette industry is known to cause market failure. It burdens society with disease and reduces social economic welfare. These negative externalities are thought to far outweigh any economic benefits that the industry yields (Guhl & Hughes n.d). To combat this, governments implement indirect taxes with the aim of reducing the number of smokers. Evidence shows that this has been the most effective means of reducing demand for cigarettes (Cotter, Dunclop & Perez 2011). In the context of the competitive model, this essay will explain how taxes on cigarettes reduce demand, including discussion of the short-term and long-term price elasticity of demand, how the tax burden is distributed between consumers and producers, redistribution of income, and resulting market inefficiencies.
Although the Australian tobacco industry is an oligopoly, the presence of competition means that the market operates in a similar way to that of a competitive market (Zhang, S 2015, email, 5 January). Producers set the price and produce a quantity of output that is determined by the competitive equilibrium. Graph A demonstrates that this is the point at which the demand (D) and supply (S_1) curves intersect (Stiglitz et. al. 2014 pp. 51-2). The equilibrium price (P_1) and quantity (Q_1) of cigarettes are fundamentally dependent on the price elasticity of demand.

Price elasticity of demand (PED) for cigarettes varies amongst demographics (age, socio-economic background etc.) (Chaloupka 1998).…
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