Introductory Economics: Analysis of Cigarette Tax and Vaping

This essay provides an analysis of an article focusing on the effects of government taxation on cigarettes in the United States. The essay delves into microeconomic theories, including price elasticity of demand, substitute products (particularly vaping), demerit goods, and government tax polic...Read More

Running head: Introductory Economics
Introductory Economics
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1Introductory Economics
Table of Contents
Introduction................................................................................................................................2
Article Analysis..........................................................................................................................2
Source.....................................................................................................................................2
Summary................................................................................................................................2
Microeconomic concepts associated with the article.............................................................3
Price elasticity of demand..................................................................................................4
Substitute product...............................................................................................................4
Demerit goods....................................................................................................................4
Government tax..................................................................................................................5
Analysis of the article.............................................................................................................5
Conclusion..................................................................................................................................7
References..................................................................................................................................8

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Introduction
Microeconomic theory proposes many important theories that help to understand
market structure of an industry. The article selected in the essay for analysis pertains to the
effect of imposition of tax on cigarette. The focus of the essay is on the policy of goods tax
that the government of the United States used to discourage the consumption of cigarette and
thereby smoking. This essay provides a detailed summary of the article along with the reason
of use of the tax on goods to discourage cigarette smoking. It will also discuss the effect of
the tax on cigarette and the reaction of the consumers in presence of a close substitute that is
vaping products especially e-cigarette. Discussing about the effect of the tax on good policy
the viability of the policy has been discussed. The essay also tries to provide and focus on the
possible outcomes under government tax on demerit goods in absence and in presence of
substitute goods. Hence, the essay focusses on the theory of demerit goods along with other
microeconomic theories of government tax, price elasticity of demand and substitute goods
while analysing the article.
Article Analysis
Source
https://www.marketwatch.com/story/people-are-turning-from-cigarettes-to-vaping-for-
reasons-other-than-their-health-2019-07-02
Summary
This article emphasized on the consumption of smoking products and effect of change
in prices of the products on the consumption of the same. The smoking products that are
discussed in the article are cigarettes, e-cigarettes and vaping. The article studied that an rise
in the price of cigarettes due to imposition of $1 tax has decreased overall consumption of
cigarette by 1.9% and there was a decline in 3.5% of consumption by daily smokers. In

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contrary to this the consumption of vaping increased by 9.7%. The data based on a report of
Narional Bureau of Economic Research. In the, article it has been mentioned that a research
conducted on smoking and took poll of 400, 000 adults and surveyed 33, 000. The study
found that tax on cigarette discourage the smoker and consumption of the product decreased
whereas consumption of e-cigarette has increased. Thus, the article focuses on the shift from
traditional cigarette smoking to e-cigarette smoking. The tax imposed on traditional cigarette
is different in different states. The average tax on cigarette is $1.81 with highest tax rate
$4.35 in New York. However, it is been observed that taxation has been fruitful in reducing
consumption of traditional product but inclination toward the consumption of e-cigarettes has
been pushing the teens to traditional smoking, which is not desirable of effect of taxation.
Thus, nine states in the US including Washington DC have imposed tax on vaping products.
This imposition of tax on vaping products has weakened the effect of tax on traditional
cigarette because the smokers who were switching to e-cigarette due to tax was not switching
any more as the price is gap between vaping products and cigarette has reduced. According to
the article, it is proven that e-cigarette is about 95% less harmful than traditional cigarette.
Thus, a tax on vaping product that would not weaken the tax effect of traditional cigarette is
required.
Microeconomic concepts associated with the article
The article studied in the report pertains to microeconomic theory of price elasticity,
substitute product, government taxation and demerit goods. The price elasticity explains the
change in demand of cigarette due to change in price occurred owing to imposition of tax by
the government (Coglianese 2017). The effect of presence of substitute product is also
significant on the consumption of traditional cigarette (Duan, Yao and Huo 2015). Products
related to smoking are categorised under demerit goods as per micro economic theory (Evans
and Popova 2017). Thus, using these theories of microeconomics the analysis of the article

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will be made and the effectiveness of the government tax of the smoking products is
discussed in the following paragraphs.
Price elasticity of demand
The magnitude of alteration in quantity demanded of a good due to alteration in its
price is measured using the concept of price elasticity of demand (Jawad et al. 2018). Thus,
price elasticity of demand can be described as the sensitivity of demand for a good to its
alteration in price. A good is said to be price elastic if the value of price elasticity of demand
is equal to 1, and it is price inelastic if the value is less than 1 (Arzaghi and Squalli 2015).
Alternatively, if the value of the price elasticity of demand is much higher than 1 then the
good is said to be highly elastic. Price inelastic meant that the change in demand for product
is very low due to significant change in price. On the other hand, price elastic means the
alteration in demand is proportional to the alteration in price, and when it is highly elastic
then demand changes more than proportionately due to the change in price (Diederich and
Goeschl 2017). For, different products price elasticity of demand is also different.
Substitute product
In microeconomic theory, a substitute product can be defined as the product that
provides utility and pleasure similar to another product that a consumer consumes. A change
in demand, supply and price of a product also affects the similar factors of its substitute
product. In the article, traditional cigarette and e-cigarette or any other kind of vaping
products are all substitute product to each other (Jensen et al. 2015). Other examples of
substitute products are tea and coffee, ice cream and brownie, butter and cheese and many
more.

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Demerit goods
There are different types of goods that are explained in the microeconomic theory
such as normal goods, luxury goods, giffen goods and demerit goods (Klein 2018). The
article in this report discusses about demerit goods. Thus, focus will be given to demerit
goods only. The goods that are addictive in nature and has particular segment of consumers
who purchase it are commonly known as demerit goods in economics. Price elasticity of
demerit goods are very inelastic when change in price is only considered, however, if there is
substitute of the demerit good then demand changes significantly with change in price
(Minagawa and Upman 2019).
Government tax
In microeconomic theory, tax is defined as a tool that government uses to control the
market. The imposition of tax is mainly done in the cases of social welfare loss and market
failure under microeconomic theory (Allcott and Kessler 2019). The government tax in the
concerned article is used to discourage the consumption of demerit good that generates loss in
social welfare by affecting health of the consumers.
Analysis of the article
The tax on cigarette is used to discourage the consumption of cigarette. The
fundamental theory of microeconomics, demand and supply states that with increase in price
demand for a product falls. Thus, the government imposes tax on cigarette with an objective
to reduce its consumption. However, cigarette is a demerit good and it is known that these
goods are very price inelastic. Thus, effect of tax would be negligible as people are addicted
to cigarette and would not reduce its consumption
due to tax induced price rise. The effect of the tax
can be seen in the diagram given below.

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Figure 1: Tax on demerit good
Source: (Created by the Author)
The demand curve of demerit goods like cigarette is very steep almost close to
vertical demand curve. Thus, change in price would not change of such goods. In the figure
given above it can be seen that a tax is imposed on a demerit good that increases the price
from P to PT, which is much higher than the previous price. However, the demand fell by
negligible amount from Q to QT. It can be observed that the change in demand is very low
and Q and QT are almost equivalent. The notion of this low change in quantity demanded is
the assumption that there is no substitute for the given product. Moreover, in the article there
is substitute for cigarette and that is e-cigarettes. Thus, there is option for consumers or
particularly smokers have option to switch product if price of one product rises. Hence,
cigarette demand curve will be much flatter than the demand curve shown in figure 1. The
change in the slope of the demand curve of cigarette is shown in the figure 2.

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Figure 2: Flatter demand curve of cigarette
Source: (Created by the Author)
The flatter demand curve of cigarette will cause to reduce the demand for the product
significantly due to imposition of government tax. The fall in demand is from Q to QT, the
difference in demanded quantity in this case is much higher than the previous one. The
reduction in demand of cigarette is almost equivalent to the increase in demand for the vaping
products, since the consumers switched to e-cigarettes due to increase in price of cigarettes.
Thus, the government tax in this case is not enough successful in discouraging smoking.
Considering the theory of demerit goods, it can be concluded that the imposition of tax is not
effective way of discouraging smoking. The consumption of cigarette or any kind of smoking
will reduce only when the consumers will become conscious about their health.
Conclusion
The above analysis of the article helps to understand microeconomic theories like
demerit goods, tax in goods and price elasticity of demand and substitute of products. From
the article it can be understood that how the above mentioned microeconomic theories are
inter related and response to each other’s changes. The exception in the case of demerit goods
has also been observed that how the demand of demerit good changes depending on presence
and absence of substitute products. The demand of cigarette would not have changed by the
amount it changes if there was not any available substitute product of it. Thus, the article has
convincingly used the microeconomic theory in explaining the effect of government tax on
cigarette in the US.

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References
Allcott, Hunt, and Judd B. Kessler. "The welfare effects of nudges: A case study of energy
use social comparisons." American Economic Journal: Applied Economics 11, no. 1 (2019):
236-76.
Arzaghi, Mohammad, and Jay Squalli. "How price inelastic is demand for gasoline in fuel-
subsidizing economies?." Energy Economics 50 (2015): 117-124.
Coglianese, John, Lucas W. Davis, Lutz Kilian, and James H. Stock. "Anticipation, tax
avoidance, and the price elasticity of gasoline demand." Journal of Applied Econometrics 32,
no. 1 (2017): 1-15.
Diederich, Johannes, and Timo Goeschl. "To mitigate or not to mitigate: The price elasticity
of pro-environmental behavior." Journal of Environmental Economics and Management 84
(2017): 209-222.
Duan, Yongrui, Yuliang Yao, and Jiazhen Huo. "Bullwhip effect under substitute
products." Journal of Operations Management 36 (2015): 75-89.
Duan, Yongrui, Yuliang Yao, and Jiazhen Huo. "Bullwhip effect under substitute
products." Journal of Operations Management 36 (2015): 75-89.
Evans, David K., and Anna Popova. "Cash transfers and temptation goods." Economic
Development and Cultural Change 65, no. 2 (2017): 189-221.
Jensen, R. Paul, Wentai Luo, James F. Pankow, Robert M. Strongin, and David H. Peyton.
"Hidden formaldehyde in e-cigarette aerosols." New England Journal of Medicine 372, no. 4
(2015): 392-394.
Klein, Peter G. "A note on Giffen goods." Unpublished, s/d. Available at:.. Acessed in:
October 10 (2018).

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Minagawa, Junichi, and Thorsten Upmann. "Price Effects on Compound Commodities." The
Scandinavian Journal of Economics 121, no. 2 (2019): 630-646.