Economic Analysis of Cigarette Taxation

The assignment content discusses the economic analysis of imposing a tax on cigarettes. It explores how the tax affects demand and revenue for different age groups and income levels. The discussion also includes the impact of advertising bans on the tobacco industry, with a focus on profit maximization and reduced competition. The content also includes bibliographic references.

Running head: ECONOMIC ANALYSIS
Economic Analysis
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1ECONOMIC ANALYSIS
Table of Contents
Exercise 1.........................................................................................................................................2
Exercise 2.........................................................................................................................................5
Bibliography....................................................................................................................................6

2ECONOMIC ANALYSIS
Exercise 1
a) The imposition of tax on cigarette will reduce the demand for cigarette more than its
price for teenagers. Hence, revenue will not increase much. For young adult and adult
demand is inelastic. Therefore, for these groups demand reduces less than the price and
lead to a significant increase in government revenue.
b) The young adults tend to smoke less regularly than old adults do. Hence, adults have less
elasticity. The dependency on tobacco is least for the teenagers making demand highly
elastic.
c) Low-income groups generally have high-income constraints. All of their income is
mostly absorbed in meeting demand for necessary goods and left a few margin of income
to spend on tobacco. This makes tobacco demand highly price sensitive.
d) If the demand for low-income groups becomes inelastic then people belonging to these
groups are unable to cut their consumption much with price increase for tax imposition.
This can lead to shortage of funds for other necessary good in budget.

3ECONOMIC ANALYSIS
e)
Figure 1: Impact of levying tax on cigarette
(Source: as created by the Author)
f) With imposition of tax price paid by consumers increases from P* to P1 and this reduces
consumer surplus from an earlier ΔEP*G to a small triangle ΔAP1G. The price received
by cigarette seller reduces from P* to P2. At the new price, producer surplus decreases
from ΔEP*F to ΔBP2F. Total surplus is reduces and there is a deadweight loss imposed
on society.
g) Welfare analysis using only consumer and producer surplus covers the monetary value
buyers and sellers impose on direct consumption and production of the good. However,
for addictive items there are associated cost apart from price paid by the consumer.
Therefore, a broader measure that incorporates such additional cost is needed.

4ECONOMIC ANALYSIS
h)
Figure 2: taxation in Rollies market
(Source: as created by the Author)
With a lower proportionate tax rate in rollies market, the price hike with taxation is
smaller and thus burden on both the buyers and sellers will be less as compared to market in
tailor made cigarette.
i) The combined impact of rollies and tailor made cigarette should be considered to
understand the overall impact of taxation. The loss in consumer and producer surplus is
less in Rollies market than that in tailor market. The welfare cost or deadweight loss is
also less here. Therefore, with more buyers switch to Rollies the welfare loss or the
burden of taxation will be reduced.

5ECONOMIC ANALYSIS
Exercise 2
a) Advertising has a positive impact on demand. Advertising conveys information about product
and prices to the consumers. With a ban on advertising consumer has less information and
demand becomes less responsive. This makes demand curve steeper by increasing slope of the
demand curve.
b) Advertising affects both consumers and producers. It affects producers by increasing
competition. When competition increases, then seller has less market power. Now, with a ban on
advertising competition among the existing and new companies reduced and this gives
companies more power on price setting for tobacco product.
c)
Figure 3: Profit maximization with advertising ban
(Source: As created by the Author)
With a reduced competition, tobacco companies can chose a higher price and earn a
greater profit.

6ECONOMIC ANALYSIS
Bibliography
Huang, J., Zheng, R., Chaloupka, F.J., Fong, G.T. and Jiang, Y., 2015. Differential
responsiveness to cigarette price by education and income among adult urban Chinese smokers:
findings from the ITC China Survey. Tobacco control, 24(Suppl 3), pp.iii76-iii82.
Resnick, M. and Albert, W., 2014. The impact of advertising location and user task on the
emergence of banner ad blindness: An eye-tracking study. International Journal of Human-
Computer Interaction, 30(3), pp.206-219.
Stiglitz, J.E. and Rosengard, J.K., 2015. Economics of the Public Sector: Fourth International
Student Edition. WW Norton & Company.
Yao, T., Ong, M.K., Max, W., Keeler, C., Wang, Y., Yerger, V.B. and Sung, H.Y., 2017.
Responsiveness to cigarette prices by different racial/ethnic groups of US adults. Tobacco
control, pp.tobaccocontrol-2016.