Impact of Sales Tax on Tobacco Market

Question: Discuss the impact of sales tax on tobacco market. Answer: The tobacco is sold in the purely competitive market. Therefore, price level is set through market mechanism. It is set at a level, where the demand for tobacco is equal to supply of tobacco. This price brings the market of tobacco in equilibrium. In equilibrium price, the quantity for tobacco supplied is equivalent to the quantity demanded. The equilibrium price is also called the market price. The market price changes, when there is any change in the variation in the demand and supply of tobacco. When price increases, there will be excess supply, as people demand less of tobacco and supplier will supply more of it. Since, there is lack of demand for tobacco, the supplier will eventually reduce their supplies to an extent where it is equal to demand and at that point, the market will again attain equilibrium. Similarly, as price decreases there will be shortage of supply due to more demand and less supply. In this case, the supplier may like to meet some demand generated for tobacco or due to lack of supply; people will curb their willingness to buy tobacco. In this way, there will be no shortage of supply and market will reach the equilibrium (Mankiw 2015). Therefore, through demand and supply mechanism, the market will always be in the equilibrium position. In a perfectly competitive market the equilibrium level will be at the level where the price is determined at the point of interaction of demand and supply. The prices will adjust and so will the demand and supply. Figure: equilibrium price for tobacco The above figure shows that initially the market is at equilibrium at point E and the equilibrium price is P1 and Q1. Due to the rise in the price of tobacco the supply increases and the demand falls. Due to excess supply of the tobacco the supplier has to adjust and so the price falls to equilibrium level. Hence in a competitive market the price of the product will always in equilibrium. Due to increase in the sales tax, the price of tobacco will increase. Other thing remaining constant, the demand will fall along the demand curve and the supply will increase along the supply curve as price has increased. As the sales tax has been imposed on tobacco, the real income of the people of Australia has been fallen. Moreover, as the supplier has to pay tax for selling tobacco, their cost of production has increased. This change will be reflected through the shift in the supply curve. The supply curve will be shifted to the left, as there has been a decrease in the supply. However, due to sales tax imposition, the producers of tobacco will also raise the price of the product in order to manage the high cost of production. Due to the price rise of tobacco, this will lead to fall in the real income, which will curb the demand for tobacco (Meyer 2012). The demand curve will be shifted to the left. The interaction point of this new demand and supply curve will determine the new price and quantity of tobacco. Figure: impact of sales tax on tobacco market Imposition of sales tax by the government on the tobacco market will raise the cost of tobacco for the suppliers (Baumol and Blinder 2015). Hence the supply will fall and so the curve shifts to left. The demand for the tobacco falls in the market. Hence the price for tobacco rises. The economy will face a deadweight loss due to consumer and producer loss. The buyers face loss due to rise in the price of tobacco and the sellers face loss due to the tax that the government has applied in the tobacco market. The demand for tobacco is inelastic, as those who are addicted to it will like to buy it in spite of the high price. Even at the high price the demand for tobacco will be high due to the addiction of the consumer. This means that the change in quantity demanded of the product will have not have much effect due to the changes in the price of the product. Figure: inelastic demand curve for tobacco Though the tax is imposed on the producers, but they shift the burden to the consumers by charging high price (Rader 2014). However, how much share of tax incidence will be shifted to consumers and how much the producers will face, depends on the responsiveness to the price change, i.e. on the elasticity of demand and supply. However, the ultimate gainer will be government who will earn the tax revenue (Frank 2014). The above diagram shows that the even though the price is changing by large amount, the quantity demanded for the product changes by a very negligible amount. Hence the demand curve for tobacco is inelastic in nature. When the price for tobacco is inelastic in nature then the consumer pays most of the sales tax. This is done because the consumer is ready to pay any amount for the product. The supplier shifts its tax burden to its customers by raising the price of the product to cover up the cost. This process can be explained with the help of diagram. Figure: A Tax When Demand Is Price Inelastic and Consumer pays Most of the Tax The society will face a deadweight loss due to rise in the tax. The price of the tobacco is rises due to implication of tax but this does not have an effect on the quality of tobacco (Hildenbrand 2014). The supply of the tobacco falls but the tax burden will shift to its consumers and the buyers will be in loss due to inelastic demand of the tobacco. Apart from the rising taxes, the government can increase awareness among the people regarding the ill effect of consuming tobacco. Health caution in the cigarette packets and increasing awareness regarding health issue can discourage the smokers. Moreover, it can also put a ban on smoking and/or penalize the smokers. The production of tobacco can be banned or by acquiring the land used for tobacco cultivation can be seized and used for other cultivation activities. Therefore, the supply side policy seems to be more effective than the demand side policy (Canto, Joines and Laffer 2014). By reducing the supply of tobacco by a significant amount, the availability of tobacco will be reduced and price will be too high. Therefore, there will be scarcity of tobacco, price will be unaffordable, and smoking will be discouraged. There are various ways; the government can adopt to reduce tobacco apart of imposing taxes. The main policy that the government can adopt to reduce the smoking is educa ting the consumers. The government can also ban sales promotion of tobacco. Recommendation should be given to the shoppers not to display the tobacco products (Chaloupka, Yurekli and Fong 2012). Anti smoking campaigns is another measure to reduce the consumption of tobacco and the related products. This helps in making people aware of the health dangers of smoking. E-cigarettes or the electronic cigarettes are safer than the tobacco. Hence it is advisable for the consumers to consume the product that is safer. Cultivation of tobacco (Gruber 2012) should also be discouraged which will automatically reduce the supply of the tobacco products. Warning labels in the packet of cigarettes will also make the consumers aware of the product. A proper treatment can be given to the consumers addicted to smoking. Indirect economic incentives also discourage consumption of tobacco. This is indirect means of controlling the consumption of tobacco. The supply of the tobacco will be decreased through the policy. As a result, the availability of the tobacco can be reduced and in spite of inelastic demand, the government can prevent the usage of tobacco by alternative policies. The suppliers or the producers of tobacco will be the loser, but the society as a whole is the winner as their wellbeing has enhanced (Francis 2014). The supplier will face loss because the demand for the product falls due to rise in awareness. The income that is generated from selling the tobacco will also fall due to which the suppliers will face loss. The consumers will be in benefit because the health condition of the consumers will improve. The overall well being also improves as the society as a whole benefits from the reduction of tobacco. References Baumol, W.J. and Blinder, A.S., 2015.Microeconomics: Principles and policy. Cengage Learning. Canto, V.A., Joines, D.H. and Laffer, A.B., 2014.Foundations of supply-side economics: Theory and evidence. Academic Press. Chaloupka, F.J., Yurekli, A. and Fong, G.T., 2012. Tobacco taxes as a tobacco control strategy.Tobacco Control,21(2), pp.172-180. Francis, M.C., 2014. Theory of Demand and Supply. Frank, R., 2014.Microeconomics and behavior. McGraw-Hill Higher Education. Gruber, J., 2012. Principles of Microeconomics. Hildenbrand, W., 2014.Market demand: Theory and empirical evidence. Princeton University Press. Mankiw, N.G., 2015. Principles of Microeconomics, Cengage Learning. Meyer, L.H. ed., 2012.The supply-side effects of economic policy(Vol. 1). Springer Science Business Media. Rader, T., 2014.Theory of microeconomics. Academic Press.