The Effects of Taxation and Demand on Tobacco Consumption and Pricing

This assignment delves into the economics of the tobacco market, examining the price elasticity of demand and the effects of taxation. It analyzes how price changes influence consumer behavior, particularly among different age groups and income levels. The assignment explores the impact of taxes on tobacco consumption, tax revenue, and the potential for black markets. It also discusses the influence of government policies like taxation and bans on the pricing power of tobacco companies. The analysis includes the effects on consumer welfare, the role of rollies, and the relationship between marginal costs and revenues. The assignment provides a comprehensive overview of the factors influencing the tobacco market and their economic implications.

Exercise 1: Price Elasticity of Demand for Tobacco & Taxation
Most studies find that younger people are more sensitive than older people to increases in the price of
cigarettes. The average price elasticity of cigarettes for teenagers is –1.43, –0.76 for young adults,
and –0.32 for adults. Another factor influencing elasticity is income with studies in high-income
countries finding greater price sensitivity of tobacco among those on lower incomes.
a) There will not be much impact on government revenue. This is because there is a negative
relationship between price and the quantity demanded hence, the tax will have a less than
significant effect on tax revenue.
b) First, teenagers might be on the experimenting phase of using the cigarettes and therefore
as price increases may reduce their interest in the cigarettes as they might seek
alternatives. The older individuals have already formed a habit of smoking.
c) Lower income groups may look at the effect of the price increase in making other
discretionary purchase, therefore if there is a significant increase, they may opt out.
d) Increase in the taxes of the price of cigarettes increases the budgetary allocation for the
tobacco for the consumers.
e)
The impact of levying the tax may increase the supply due to expectations of price
increase. This may therefore reduce the equilibrium price due to a maintenance of the
demand for cigarettes.
f) The levying of taxes may decrease the welfare of individuals especially since it may affect
their home budgets related to other discretionary purchases.
g) Yes, this is because there is need to assess the impact of levying taxes not only on the
individual’s health but also impact on budget.
h)
The rollies may decrease the demand for cigarettes which may further reduce the equilibrium price.

i) The switch to rollies negatively imapcts the welfare of the consumers mostly because it is
a health hazard to them
Exercise 2: Price-Takers and Price-Setters
a) The slope of the demand curve may decrease due to less awareness of the product and
hence reduce its demand.
b) Impact of the ban may limit the price setting power of the tobacco companies since
there arises black markets for the product in which people can purchase for lower
amounts.
c)
The profit maximization level may decrease since there are fewer marginal costs compared to
marginal revenues.