Economics of Tobacco: Market Competition, Tax Incidence, Elasticity

This assignment examines the Australian tobacco market, assessing its characteristics against a perfectly competitive market structure. It analyzes the impact of tobacco tax increases using supply and demand diagrams, detailing changes in consumer surplus, producer surplus, and tax revenue. The analysis includes the concept of elasticity, explaining how low-income earners' demand differs from high-income earners in response to tax imposition, and illustrates the effects on equilibrium price and quantity. The assignment concludes by discussing the implications of elastic and inelastic demand in the context of tobacco taxation and its impact on different income groups. Desklib is your go-to platform for similar solved assignments and study resources.

Tobacco Market
(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.
Some of the major characteristics of the perfectly competitive market are follows:
In a perfectly competitive market the seller of the products are the price takes and sells the
products at a price that is decide d by the forces of market demand an d market supply of
demand
There are a large number of producers in the market and the contributions of such large number
of producers are insignificant with respect to the total supply of the market and therefore the
individual producers cannot change or affect the total supply or supply curve of the market
All the producers are producing the homogenous products and the entry and exit with respect to
the market is free.
The Tobacco Market of Australia to great extent posses the characteristics of a perfectly
competitive market as there are large number of cigarette suppliers as well as producers in the
market who sells the cigarette at apprise that is decided by the forces of demand for and supply
of cigarette in the market.
The individual supply quantity of each of the suppliers in the market is insignificant and the
producers of the product are free to take an entry and to make an exit from the market. Thus the
Tobacco Market of Australia can be described as a 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 animposition of

a tax in the market for cigarettes, identifying the changes in consumer surplus, producer
surplus and tax revenue.
AS described by the above figure in the competitive tobacco market of Australia a tax amount of
“TT1”has been imposed and the current tax inclusive price of a packet of cigarette in Australia is
$40 which is indicated by P1 in the above figure. Due to the imposition of the “TT1” amount of
tax the supply curve has strictly shifted in an upward direction from S0 to S1. The imposition of
the tax has reduced the consumers’ surplus, producers’ surplus and the collection of tax revenue
collection of the government has increased1.
The consumers’ surplus before imposition of tax =A+B+C
Consumers’ surplus after the imposition of tax =A
Producers’ surplus before the imposition of tax = D+E+F
Producers’ surplus after the imposition of tax = F
1 https://econfix.wordpress.com/2015/09/28/as-revision-indirect-taxes/
T
T1

S0
S1
D
D0D1
S0
S1
D
D0D1
Rise in tax revenue collection that goes to the government =B+D
The amount of deadweight loss = C(dead weight loss out of consumers’ surplus)+E(dead weight
loss out of producers’ surplus)
Thus the amount of “B” out of the consumers’ surplus has been transferred to the government as
tax revenue due to the imposition of tax
Thus the amount of “D” out of the producers’ surplus has been transferred to the government as
tax revenue due to the imposition of tax
The amount of “C” has been transformed to deadweight loss out of consumers’ surplus
The amount of “E” has been transformed to deadweight loss out of producers’ surplus
(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 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

A demand is described as inelastic if with 1 unit change in cost or price of the product the
corresponding decrease in demand for the product will be less than 1 unit.
A demand is described as elastic if with 1 unit change in cost or price of the product the
corresponding decrease in demand for the product will be more than 1 unit2.
The above diagram describes that in case of the poor person the demand for cigarette is relatively
elastic and the imposition of tax will bring a proportionately higher decrease in demand as the
poor persons will inevitably set aside a smaller portion of limited income for the purpose of
smoking in comparison to the situation of before the imposition of the tax. However the rich
income earners will maintain same portion of the income for smoking purpose so the rise in price
of cigarette due to the imposition of tax will cause a comparatively lesser decrease in demand as
their demand is relatively elastic in comparison to poor persons.
2 https://www.thebalance.com/elastic-demand-definition-formula-curve-examples-3305836