Australian Tobacco Excise Tax, Demand And Supply Analysis, And Market Structures In Australia

Impact of excise tax increase on tobacco producers and consumers

The Australian government has increased the excise rate of tobacco by 12.5% as at 1^st January, 2018 (Health.gov.au, 2018). Hence, the producer has charged the price of a standard 20 packet of cigarettes including this tax rate.

Here, the price of a standard packet of cigarette is $ 30 including 12.5% tax rate.

Let, the before tax price of a standard packet of cigarette is $ X.

Hence, after imposition of tax, this price has become $ (X+ 12.5% of X), which is equal to $ 30, that is, (X+ 12.5% of X) = 30…… (1).

By calculating equating 1, the value of X can be obtained.

• (X+ 12.5% of X) = 30
• X + (X/8) = 30
• 8X + X = 30 * 8
• 9X = 240
• X = 240/9
• X = 26.67

Thus, from this calculation, it can be stated that the before tax price is $ 26.67. 

After imposition of a tax, the supplier can reduce the supply of this product, as it leads the production cost of tobacco to increase further (Ross, Tesche & Vellios, 2017). This can be discussed with the help of a suitable diagram of demand and supply. 

In figure 1, the demand and supply of tobacco has been drawn. The initial supply curve is denoted by S0 along with the initial demand curve D0. The amount of market equilibrium can be determined by equating these two curves. In the above figure, equilibrium level of output is Q0 and corresponding level of price is P0. However, after imposition of tax, supplier has reduced the supply of tobacco and this in turn has shifted the supply curve toward left, that is, from S0 to S1. Consequently, price has increased by P0 P1 unit while the quantity supplied of tobacco has decreased by Q0 Q1 unit (Zoutman, Gavrilova & Hopland, 2018). Thus, after imposition of tax, the cost of tobacco production has increased consequently and to cover this excess cost, the seller has increased the price of this concerned product.

To determine the actual taxpayer, it is essential to discuss about the impact and incidence of tax to analyze the share of tax burden between sellers and buyers (Farrell, 2017). In this context, the tax is imposed on the seller and this in turn has increased the cost of production of this concerned person. Consequently, the seller has increased the price of tobacco, as it is an inelastic good. This means, after increase in price, the demand for this product cannot be decreased. Hence, by paying higher amount of price, buyers are bearing this tax. Thus, it is an indirect tax, where tax is imposed on one person and is paid by another one.

Demand and supply analysis of tobacco

The demand for tobacco can be obtained from the perspective of a consumer. According to the law of demand, price of a product has inverse relation with its quantity demanded while other factors are considered as fixed (Kannai & Selden, 2014). Here, other factors are consumers’ income along with their tastes and preferences and price of relative commodities. However, increase in price of tobacco does not influence its demand by large extend for those people, who are addicted to it. Hence, the demand law is not strongly applicable in this situation (Doogan, Wewers & Berman, 2018). For this reason, inelastic demand curve for this specified product can be observed. This means, the percentage change in quantity demanded for tobacco is less compare to its percentage change in its price. Hence, the demand curve is a steeper one with negative slope (Gray et al., 2017). Consequently, by increasing the price with significant amount, the demand for tobacco cannot be reduced within the market.  The above figure has supported the view, where the degree of price has changed, that is P0P1 unit, is greater compare to the amount of change in quantity demanded, that is Q0Q1 unit. 

That is, Own-price elasticity of tobacco (Et) = percentage change in quantity demand

                                                                           for tobacco/ percentage change in its

                                                                            price

Where, the amount of P0P1 > the amount of Q0Q1

Thus, this phenomenon has helped seller to shift the tax on consumers.   

a)

Table 1: ATC, AFC, AVC, MC of a perfectly competitive firm

In table 1, Q and TC denote different levels of output and total cost, respectively. With the help of those data, average total costs (ATC), average fixed costs (AFC), average variable costs (AVC) and marginal costs (MC) have been determined. For different level of output, ATC can be obtained by dividing total cost with its corresponding output (de Jong et al., 2017). Moreover, the firm has bear 50 amount of total cost, when output has remained nil. This implies that the total fixed cost of this firm is 50 units, which is fixed for each level of output. Hence, by dividing total fixed cost with the number of output of each level, average fixed cost can be obtained. Total variable costs, on the other side, can be determined as well. The difference between total cost and total fixed cost of each output level has provided the total variable cost (Garmon, 2017). This cost is required to divide with the number of output by which, average variable cost can be obtained. Marginal cost represents the difference between total costs when one unit of extra output has been produced.

Market structures in Australia

Under perfect competition, short-run equilibrium can be determined at a particular level, where price and marginal cost equate with each other. Here, the marginal cost for 7 unit of output is $ 30 and for 8 unit of output, this cost is $40. Thus, at $35 dollar price level, the producer can produce any amount of output between 7 and 8 (Huang, Ueng & Hu, 2017). However, for the long run, the firm has obtained its equilibrium position when price equates with marginal cost while the average cost has remained at its minimum level. This is because, under long run, each firm has received the normal profit only. This means, at long run equilibrium, price, marginal cost and average become equal. From the above table, it can be seen that the minimum AC is $ 37.14285714 at output level 7 while at output level 8, it has become $ 37.5. Hence, the amount of equilibrium output for this perfectly competitive firm cannot be obtained in the long run (Kolmar & Hoffmann, 2018).  Rather, the firm can exit from the market due to its higher level of cost. 

This market structure has consisted with the characteristics of both perfectly competitive market along with monopoly one. Hence, under this monopolistic competitive market, large numbers of sellers or firms can be seen while they can freely exist from the market or can enter into the one. In addition to this, the market has also possessed large numbers of buyers (Bertoletti & Etro, 2017). These characteristics are similar like the perfectly competitive one. However, the chief feature of this monopolistic competitive firm is the ability to sale slightly different products, which are close substitute but cannot perfectly substitute. From this perspective, each firm has enjoyed monopoly nature (Mahoney & Weyl, 2017). Hence, it has possessed negatively sloped demand curve and consequently can charge higher or lower prices compare to other firms. Thus, to sell their products in market, firms have required to advertising those, due to strong level of competition among them. 

In figure 2, the short-run equilibrium of a firm has been depicted. Here, the firm has experienced excess profit by the shaded area. Here, the average revenue (AR) curve has represented the downward slopping demand line for an individual firm while marginal revenue (MR) curve has lied below the AR curve. The firm can obtain its equilibrium level of output corresponding to its price level when the marginal cost curve intersects its average revenue curve.

Economies of scale concept and merging of local government councils in Australia

This form of market structure can be bound in various industries. For instance, within the hotel industry, each hotel provides almost same kind of services but not the exactly same one. hence, to promote business, those hotels have advertise about their exclusive services.

The oligopoly, on the other side, has different market structure compare to the monopolistic perfect market. This market has small numbers of firms as other firms cannot freely enter into the market or any firm cannot easily exit from here. Under this market condition, firms do not strongly compete with each other, rather they consider the reaction of their competitors and based on this, they set their own business decision (Kamei, 2017). Each firm, within its market strategy, has considered two chief decisions regarding competition and prices.

In Australia, banking sector has experienced this kind of market structure, where four large banks have operated their business, viz., Commonwealth Bank of Australia, Australian and New Zealand Banking Group, Westpac and the National Australian Bank (Bakir, 2017). 

The economic rationale for merging local government councils in some states of Australia can be described with the help of some economical concepts(Li, Cui & Lu, 2018). For instance, economies of scale, the capacity of local government, economies of scope along with administrative and compliance costs can be described over here.

Economies of scale:   Under the concept of economies of scale, production cost per unit of output has decreased when total output has increased simultaneously (Baumers, Dickens, Tuck & Hague, 2016). This is considered as the chief factor behind mergeing. Within the concept of optimal size of local governments, economies of scale represent a decline in the cost per person based on a particular amount of service, while service related population has increased. Hence, the larger unit of jurisdiction can decrease per capita costs related to service provision, significantly (Blesse & Baskaran, 2016). In general, economies of scale are chiefly depended on the technological nature related to production system.

It has represented the concept of economies of scale with the help of an average cost (AC) curve. From this figure, it can be stated that the production cost of an organization has started to decline with the increasing amount of output. At Q0 level of output, AC reaches to its minimum point. Hence, economies of scale exists between 0 and Q0.

The capacity of local government: This point has also supported the concept of merging local governments, where large council intends to possess a large administrative level along with other expertise as this size has helped to employ specialist skills. However, this phenomenon cannot be obtained through local governments (Blom-Hansen, Houlberg, Serritzlew & Treisman, 2016). Local governments of Australia have received pressures from the State governments. However, after merging, those small governments have experienced significant advantage as they can achieve more tasks with difficulties and can solve these efficiently.

Economies of scope:  Economies of scope is also referred as economies of joint production. According to this concept, it becomes cheaper for an economy to produce large number of products under a single organization instead of making each type of product differently. This is also true for a local government as well. This concept is chiefly depended on the production cost. If a single organization can produce a set of services with cheaper cost rather than producing by a vast number of services, then the organization can enjoy economies of scale (Callanan, Murphy & Quinlivan, 2014). Regarding the concept of merging local governments, this concept has considered with huge importance as each small governmental entity has performed their work inefficiently.

Administration and Compliance Costs:   The large size of councils can decrease the direct costs regarding administration along with the compliance costs, which are the salary of individuals who are taking part within the political process of local government. In this context, it is beneficial to discuss about the administrative costs and compliance one. The administrative costs have included the compensation, which is paid to appointed and elected staffs and officials, who are needed to support those officials (LOIS-GONZÁLEZ & AYMERICH-CANO, 2018). On the other side, compliance costs incorporate the costs, which are incurred by voters of local governments to obtain information about issues and candidate positions. These costs also include time cost and potential cash for registering an opinion through participating in meeting, hearing and voting and so on. 

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