ATMC BUS502 Principles of Economics: Cigarette Market Analysis Report

This report examines the economics of the cigarette market, focusing on whether it can be considered perfectly competitive, analyzing the effects of tobacco tax increases on consumer and producer surplus using demand and supply diagrams, and exploring the concept of elasticity in relation ...Read More

Page 1 of 7
ATMC BUS502 PRINCIPLES OF ECONOMICS FOR
ACCOUNTANTS – SEMESTER ONE 2018
ASSESSMENT TASK 2 – RESPONSES TO ARTICLES -
ARTICLE 2

Page 2 of 7
Table of contents
(1) Can the market for cigarettes be considered a perfectly competitive market? Explain
your answer, referring to at least three characteristics of this type of market structure............3
(2) The article claims that “tobacco tax increases … may discourage smoking". Use the
simple demand and supply diagram to illustrate and explain the effects of an imposition of a
tax in the market for cigarettes, identifying the changes in consumer surplus, producer
surplus, and tax revenue.............................................................................................................3
(3) “Low-income earners tend to find it harder to quit than higher-income earners.”
Explain in your own words what this means in terms of the concept of elasticity and use the
diagrams below to compare the effects of an imposition of a tax on equilibrium price and
quantity when demand is............................................................................................................5
Reference....................................................................................................................................7

Page 3 of 7
(1) Can the market for cigarettes be considered a perfectly competitive market?
Explain your answer, referring to at least three characteristics of this type of market
structure.
Answer-
No the market for the cigarettes cannot be considered a perfectly competitive market. This is
due to the fact that the characteristics of the cigarette market do not match with the
characteristics of the perfectly competitive market. According to, characteristics of the
perfectively competitive market, the number of sellers and the number of customers of the
market need to be very high. However, in this case of the Australian market, the number of
sellers in the market is very limited. Apart from that, another characteristic of the perfectly
competitive market is that the seller produces products which are homogenous to each other.
In the reality, this market shows that products of each of the sellers of the market are different
from other sellers of the market.
Baumol & Blinder (2015) highlighted that this is the reason there are loyal customers for
each of the sellers of the market. The products of each of the sellers are at least slightly
different from the other products of the market. Furthermore, entry and exit are also not
smooth in case of Australian cigarette market for a new seller requires a license from the
government. Lastly, less control of the sellers over the prices of the market is another
characteristic which has been missing from the cigarette market Australia. The sellers of the
Australian market can easily transfer the tax amount to the customers of the market letting
them take the most burdens of the taxes (Friedman, 2017). However, as per the principle of
economics, it is not possible for any market to be perfectly competitive in the real world. Few
markets can be considered as a nearly perfectly competitive market such as that of cigarettes
market which follows few of the characteristics of the perfectly competitive market.
(2) The article claims that “tobacco tax increases … may discourage smoking". Use
the simple demand and supply diagram to illustrate and explain the effects of an
imposition of a tax in the market for cigarettes, identifying the changes in consumer
surplus, producer surplus, and tax revenue.
Answer-
The main objective of the imposition of taxes on a production of a specific good is to extract
a certain amount from the revenue of the sellers. The tax imposed by the government has the
potentiality to affect both the sellers and the customers of the market. Currie, Peel & Peters
(2016) stated that the impacts of the imposed tax will depend on the elasticity of demand for

Page 4 of 7
the concerned product. In this case, the demand for cigarettes can be considered as an
inelastic demand. This is due to the fact that cigarette is a habit sudden halt of which can lead
to trouble for the smokers. Therefore, as per the principle and the data showed that decrease
in demand for cigarette corresponding to increasing in the price has been less than the
increase in the price. This is the basic requirement for a product to be inelastic. In case of
inelastic demand for the product, the seller knows that demand will not decrease significantly
following an increase in price and hence transfer most of the tax burden on the customers of
the market.
In this case, the increased tax will increase the production cost of the sellers of the market and
hence for each price point, the seller will now sell the fewer amount of cigarettes in the
market (McKenzie & Lee, 2016). As a result, the supply curve of the market will shift to the
left keeping the demand curve unchanged.
Figure 1: the tax on cigarette
(Source: Thompson, 2016)
The resulting leftward shift in the supply curve for the cigarette following an imposition of
taxes increases the equilibrium price and reduces the quantity sold of the market. However,
due to the tax, the customers are paying the new equilibrium price whereas; the sellers are
getting a reduced price as per unit revenue. The difference between the pay of the customers
and the collection of the sellers are same as the tax amount (Lee, 2017).
The imposed tax also affects the consumer and producers surplus as well. The rectangular
area is the tax revenue that the government collects. The half of the box reduces the consumer

Page 5 of 7
surplus and the half of the box reduces the producers’ surplus of the market. The area shown
by the red triangle is the deadweight loss of the society which is gained by no one due to the
imposition of the taxes. Therefore the figure 1 shows that the tax on a cigarette may
discourage smoking as it would increase the cost of smoking.
(3) “Low-income earners tend to find it harder to quit than higher-income earners.”
Explain in your own words what this means in terms of the concept of elasticity and use
the diagrams below to compare the effects of an imposition of a tax on equilibrium price
and quantity when demand is
Answer-
The discussion on the article states that low-income groups are more attracted towards the
consumption of cigarettes. That means their addiction is more than the high-income class.
This also differentiates between the demands for a cigarette for these two customers. While
the demand for a cigarette in case of low-income earner is inelastic, the demand for the high-
income earner is inelastic as per the article. This will have different effects for different types
of smokers of the country.
Relatively inelastic
The relatively inelastic demand for cigarette reflects the steeper demand curve for the
product. In this case, the producers of cigarette understand that the demand will react less to
the changes in the prices and hence they will transfer the tax burden mostly to the customers
of the market (Nguyen & Wait, 2015). The low-income earners will not decrease
consumption significantly and they will end up spending more for the cigarettes
consumption.
Total expenditure ↑↑ = Price ↑↑ * Quantity demanded ↓
This increased expenditure will put the individual in more financial difficulties and cigarette
consumption will rise. Therefore, it becomes harder for the low-income earners to quit
cigarettes upon the imposition of the taxes.

Page 6 of 7
Figure 2: the tax on inelastic and elastic demand
(Source: Mochrie, 2015)
Relatively elastic
The study on the article claims that high-income earners are less attracted to the consumption
of cigarettes and hence the demand is also an elastic one. Most of the high-income earners are
not even addicted to nicotine and hence increase in the price of cigarettes will result in a huge
reduction in the consumption. This is represented by the flatter demand curve in the case of
high-income earners.
As a result of the imposition of taxes, the producers do not have the power to transfer most of
the tax burden on the customers of the market. This is due to the fact that increased tax
burden will compel the customers to reduce the demand and hence the producer will go out of
business. In this case, the producer takes most of the tax burdens Chauhan, 2016). Despite
that, the demand for the cigarette reduces significantly fulfilling the objectives of the
imposition of taxes. Therefore it is easier for the high-income earners to reduce cigarette
consumption compared to the low-income earners. For this reason, the article has also
discussed that the imposition of the taxes on cigarette, although reduces the consumption to
some extent, it also puts an extra burden on the low-income earners.

Page 7 of 7
Reference
Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage
Learning.
Chauhan, S. P. S. (2016). Microeconomics: an advanced treatise. PHI Learning Pvt. Ltd..
Currie, D., Peel, D., & Peters, W. (Eds.). (2016). Microeconomic Analysis (Routledge
Revivals): Essays in Microeconomics and Economic Development. Routledge.
Friedman, L. S. (2017). The microeconomics of public policy analysis. Princeton University
Press.
Lee, A. (2017). Essays in Applied Microeconomics. Columbia University.
McKenzie, R. B., & Lee, D. R. (2016). Microeconomics for MBAs. Cambridge University
Press.
Mochrie, R. (2015). Intermediate microeconomics. Palgrave Macmillan.
Nguyen, B., & Wait, A. (2015). Essentials of Microeconomics. Routledge.
Pouw, N. (2017). An Introduction to Gender and Wellbeing in Microeconomics. Routledge.
Thompson, G. E. (2016). Microeconomics: a computational approach. Routledge.