Effects Of Government Policies On Alcohol Consumption And Market Structures

Reduction in alcohol consumption

Beer drinking is a part of Australian culture over the years. However, Australian consumers are shifting from beer to other types of alcohol especially wine. Percentage of overall alcohol consumers among the Australian is higher compared to other nations. Due to the having negative health impact on health, Australian government may take policy to reduce alcohol. Effects of two policies such as imposition of higher excise tax and minimum price imposition are discussed here. However, before examining the effect of government policies, price elasticity of alcohol needs to be measured.

Table 1: Prices of different alcohol

(Source: globalalcoholprices.com, 2015)

Price of any type of alcohol is greater in Australia compared to other nations. Despite having higher price, demand for alcohol consumption is high among the consumers. It can be inferred that consumption of this product depends on tastes and preferences of consumers rather than prices. Hence, changes of price by 1% do not have much effect on the consumption of alcohol.  

If Q1 = 700 ml, P1 = $17.99 and P2 = $ 20.99 Q2= 700 ml

Alcohol consumption in Australia is price inelastic. It indicates that consumer demands same quantity even if there is hike in price (Chung, 2014).

Impact of excise tax

As alcohol is price inelastic, the incidence of tax is borne by the consumers. Excise tax is imposed on each unit of goods produced or supplied in the market initially. Price of the product increases due to imposition of sales or production taxes (Grossman et al., 2013). Consumers bear the incidence of tax by paying higher price willingly in order to avail same quantity.

Figure 1: Impact of excise tax on consumers

(Source: created by author)

Figure 1 depicts that demand curve is vertical being price inelastic and the initial supply curve is S1. Producers reduce their supply after imposition of excise tax by the amount t per unit (Colchero et al., 2016). Supply curve shifts to the left by inflating price to the P2. As changes in price has no impact on consumers, demand remains at Q1. Consumers only pay the price t unit more than P1. It can be concluded that imposition of excise tax has no significant impact on the consumption of Alcohol by Australian consumers.

Impact of price floor

Government imposes minimum price on product in the form of price floor to restrict consumption. It is the amount, below which, a producer or seller cannot charge price to the consumers for a product. Price floor can be set above or below the equilibrium price. In order to reduce over consumption of an alcohol, price floor needs to be set above the equilibrium price. Price floor below equilibrium point would be ineffective as transaction is occurred at a market price in a free market (Richstein, Chappin & de Vries, 2014). A lower price below equilibrium level would reduce revenue of the sellers. Therefore, price floor is generally set above the equilibrium price.

Impact of Excise Tax

Figure 2: Effect of price floor

(Source: created by author)

Price is set by government externally at P_f, which is above the market equilibrium price. As demand is inelastic, there is no movement in quantity demand as monthly consumption amount is fixed. As price of the product rises due to hike in price, producers are likely to increase supply in the market. As a consequence, excess supply is created in the market at the price P_f. Excess supply makes the market unsustainable (Landsburg, 2013). Firms cannot charge lower price to equilibrate the market and possibility of losing revenue increases. In order to remove the consequence of market failure, government may purchase the surplus amount or sellers need to absorb it.

Relative merits

It can be deduced from above analysis that imposition of excise duty is better compared to price floor. Price floor creates market failure, when the demand is inelastic. Price floor is effective only when demand is elastic. In both case demand from buyer of alcohol remains unaffected due to inelasticity of the demand curve. However, there is still scope of economic welfare as revenue of government increases by widening tax base (Fogarty, n.d). The revenue can be used for public spending. On the other hand, price floor has no impact on the buyer but seller may be deprived. Therefore, impact of excise duty is greater when demand is inelastic.

a) LR equilibrium price

Figure 3: Long run equilibrium

(Source: created by author)

Long run equilibrium under monopolistically competitive market is achieved at the point where long run marginal cost equals to the marginal revenue and long run average cost (Bar-Isaac, Caruana & Cunat, 2012). Therefore, a monopolistically competitive firm operates under capacity, where LAC curve is tangent to the AR curve. Operating at the falling segment of LRAC is said to be operating under capacity. $200 is the competitive price, where form reaches at the minimum point of LRAC and a monopolistically competitive firm always earn the price greater than competitive price. A firm under monopolistic competition supply quantity according to the level MR = LRMC, however, charge price at the level P= AR = LRAC. Pm > Pc = $200. Therefore, the table manufacturer would set price greater than $200.

b) Characteristics of Oligopoly market

The distinguishing feature of the oligopoly market is existence of few firms in the market. Specific features of the market as described below:

• Existing firms depend upon each other for decision making. Decision on price and quantity supplied by one firm depends upon the initiatives and strategies of other firm. Hence, the concepts of leaders and followers exist in the market.
• Entry in the market is not easier as few numbers of firms can create significant barriers for new firm. Firms often form cartel among themselves to create barrier to entry (Feng, Li & Li, 2014).
• Product differentiation or similar products both are available in the oligopoly market. Product differentiation provides a competitive edge to the individual firm. This policy is the base of the non price competition. Price competition often results in loss for individual firm. Therefore, non price competition is better for the firm when objective is profit maximisation. Advertising special characteristics that make product differentiation successful.
• Validity of cartel depends on the reliability of firms and mutual trust among them. If one firm betrays and lowers the price, that firm can make short run profit; however, the cartel is broken down. Therefore, all the member firms of the cartel need to abide by the rules. All firms in a cartel charge uniform price and a price higher than competitive level (Sushko, 2013). Therefore, both individual profit and industry revenue can be maximised.
• Oligopolistic firms follow kinked demand curve. When a firm raises price above the kinked point, no firm follows it. However, any price reduction is followed by other firms.  

Impact of Price Floor

Three examples of oligopolistic industry in Australia are telecommunication market, super market chain and beverage. The telecommunication industry has main three competitors such as Telstra, Optus and Vodafone in Australia. On the other hand, super market industry ahs few major firms such as Coles, Woolworths, Aldi, Lidl. The beverage market operators in Australia are Coca-Cola, PepsiCo, Bundaberg, Golden Circle, Schweppes and Nudie Foods. The characteristics of product differentiation, advertisement are common among the three industries. Firms in the telecommunication such as Telstra and Optus have been successful to create significant barrier for entry in the market. Coles, Woolworths together have formed a cartel to give tough competition to the new entrants. However, Aldi has been successful to enter into the market. Nevertheless, entry in the beverage market is comparatively easier.

c) Characteristic of monopolistically competitive market

As stated by Bar-Isaac, Caruana & Cunat (2012), monopolistically competitive market has large number of firms operating with differentiated products. Market share in this industry is thus limited. The characteristics are following:

• As price competition is not profitable, advertisement and product differentiations are main medium of competition among firms.
• As existing firms can make positive profits in the short run, new firms can enter into the market easily. Entry and exit in the market is free and without any cost.
• Consumers in this market have no perfect information about product.
• Demand curve of the firm is elastic and firms operate under capacity that is before the minimum point of the long run average cost curve.

Three examples of monopolistically competitive firms in the Australian market are airlines, coffee and hotel industries. There are more than 30 airlines in the Australian market to make the market competitive. They provide same services however, internal design, passenger comfort and air fare make the market competitive. There are large numbers of hotels in the Australian hotel industry including national and international hotels. Coffee industry of Australia is also monopolistically competitive with the large number of operator. All these three industries use product differentiation as their strategy. Each firm in theses three industries take independent product decision and firms have a level of market power (Soderbery, 2014). Brand loyalty helps to attract customers towards firms. Economic profit earned by firms exists in short run. However, in long term, firms earn normal profit in long run.

d) Natural duopoly

Natural duopoly is the market when market structure supports existence of only two firms. Two firms in the market have dominant control over the market (Toshimitsu, 2012). In a duopoly market, two firms produce product taking advantage of economies of scale. They together creates significant barrier for other entrants. Cournot model can be used to explain duopoly. There is no collusion in the market. The conditions of this market are:

• No collusion
• Each firm has aim to maximise profit based on the expectation that the output decision has no effect on the output decision of other firm.
• Price is decreasing function of output.
• Cost function is c_i(q_i)
• Firms compete in quantities.

Figure 4: Reaction function of two firms

(Source: created by author)

As per Cournot model, it is assumed that cost curve of both firm are equal. Equilibrium in the market occurs where both reaction firms intersect with each other. Both firm follows their own reaction curve considering other firms output. Equilibrium achieved at the intersection point where profit of both firms are maximised. Total market share is divided among two firms and therefore can produce total output at a very low cost creating significant barrier for other firms.

References

Bar-Isaac, H., Caruana, G., & Cuñat, V. (2012). Search, design, and market structure. The American Economic Review, 102(2), 1140-1160.

Chung, F. (2014). Why do we pay so much for alcohol? Retrieved  on 21^st April, 2017, from https://www.news.com.au/finance/money/why-do-we-pay-so-much-for-alcohol/news-story/1647c23acc476553ade5d77774b8fa7d

Colchero, M. A., Popkin, B. M., Rivera, J. A., & Ng, S. W. (2016). Beverage purchases from stores in Mexico under the excise tax on sugar sweetened beverages: observational study. bmj, 352, h6704.

Feng, Y., Li, B., & Li, B. (2014). Price competition in an oligopoly market with multiple iaas cloud providers. IEEE Transactions on Computers, 63(1), 59-73.

Fogarty., J. (n.d) The own-price elasticity of alcohol: A Meta-Analysis. Retrieved on 21^st April, 2017, from https://www.library.uwa.edu.au/__data/assets/pdf_file/0018/102528/04_01_Fogarty.pdf

globalalcoholprices.com. (2015). Alcohol prices in Australia, December 2015 Retrieved  on 21^st April, 2017, from https://www.globalalcoholprices.com/alcohol_prices/Australia/

Grossman, M., Sindelar, J.L., Mullahy, J. & Anderson, R.T., (2013). Policy Watch; Alcohol and Cigarette Taxes.

Landsburg, S. (2013). Price theory and applications. Cengage Learning.

Richstein, J. C., Chappin, E. J., & de Vries, L. J. (2014). Cross-border electricity market effects due to price caps in an emission trading system: An agent-based approach. Energy Policy, 71, 139-158.

Soderbery, A. (2014). Market size, structure, and access: Trade with capacity constraints. European Economic Review, 70, 276-298.

Sushko, I. (Ed.). (2013). Oligopoly dynamics: Models and tools. Springer Science & Busines

Toshimitsu, T. (2012). Quality competition and a demand spillover effect: A case of product differentiated duopoly (No. 89). 

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