The impact of taxation on demand for tobacco products
Discuss About The Consumption In Intermediate Microeconomics.
Objective of imposition of tax on tobacco products is to discourage production and consumption of such harmful products. The consequences of the imposed tax and its effectiveness in demand reduction depends on the concerned price elasticity of demand. Price elasticity of demand is an important concept for tracing the impact of a price change on demand. By definition, price elasticity of demand is the change in demand represented as a percentage of demand before change in price as result of a change in price. The demand response is not uniform for all goods. Several factors influence elasticity of demand. Depending on these factors there are different types of elasticity. There are some goods for which magnitude of demand change exceeds that of the change in price constituting a value of elasticity greater than 1. Elasticity of this kind is termed as relatively elastic demand (Perloff, Smith & Round, 2013). There are also goods for which proportion of demand change is less than the corresponding change in price. This kind of demand elasticity is termed as relatively inelastic demand. The measured elasticity here is less than 1. The incidence of taxation-law on buyers depends on the nature of elasticity. If buyers have a relatively elastic demand, then in response to an increase in price, buyers reduce their demand largely. As buyers in this case can adjust their demand to a great extent they have to bear a less burden of tax. Reverse is the case with a relatively inelastic demand. Buyers cannot reduce their demand much in response to a high price. Because of inflexibility of demand a greater burden is borne by the people. Slope of demand curve varies depending on the elasticity of demand. With high elasticity of demand, the demand curve is relatively flatter. A steep demand curve implies a relatively inelastic demand (Norman & Wills, 2017). The demand for tobacco products tend to a relatively inelastic as people are unwilling to check their smoking habit in response to a high price.
Describes the consequence of an imposed tax on seller in light of demand supply framework. The positively sloped curve S1S1 represents the supply curve in the market. D1D1 is the associated demand curve. Following a relatively inelastic nature of the demand, the demand curve is steeper as compared to the supply curve. Before introduction of tax, a price of P1 is charged for the equilibrium quantity of Q1. An imposed tax of ‘T’ of seller shifts the supply curve upward indicating a reduction in the effective supply. The new supply curve is therefore S2S2. Buyers now pays a higher price of P2. This price is not received by the sellers. Sellers in turn receives a lower price of P3. The rectangle P2E’FP3 shows the tax revenue earned by the government. In the tax revenue he contribution to buyers is P2E’GP1, while that of sellers’ contribution is only P1GFP3. The inelastic nature of demand thus entails a greater burden on sellers.
|
Q |
TC |
TFC |
TVC |
ATC |
AFC |
AVC |
MC |
|
0 |
50 |
50 |
0 |
||||
|
1 |
100 |
50 |
50 |
100.00 |
50.00 |
50.00 |
50 |
|
2 |
140 |
50 |
90 |
70.00 |
25.00 |
45.00 |
40 |
|
3 |
170 |
50 |
120 |
56.67 |
16.67 |
40.00 |
30 |
|
4 |
190 |
50 |
140 |
47.50 |
12.50 |
35.00 |
20 |
|
5 |
210 |
50 |
160 |
42.00 |
10.00 |
32.00 |
20 |
|
6 |
230 |
50 |
180 |
38.33 |
8.33 |
30.00 |
20 |
|
7 |
260 |
50 |
210 |
37.14 |
7.14 |
30.00 |
30 |
|
8 |
300 |
50 |
250 |
37.50 |
6.25 |
31.25 |
40 |
|
9 |
350 |
50 |
300 |
38.89 |
5.56 |
33.33 |
50 |
|
10 |
410 |
50 |
360 |
41.00 |
5.00 |
36.00 |
60 |
Types of elasticity
The profit maximization condition of firm requires marginal revenue to be equal to marginal cost. In the competitive market as price is determined from the forces of supply and demand rather than discretion of sellers, the marginal revenue always equal to price (Waldman & Jensen, 2016). Therefore, profit maximization condition in the short run reduced to Price = Marginal cost. From the estimated cost table, it is evident that given price of $35 lies between a marginal cost of 30 and 40. The output thus lies between 7 and 8. Approximately 7.5 units will be produced in the short run.
The competitive market equilibrium condition in the long run requires that price is set at the minimum of average total cost. In the short run price in lower than minimum average cost of 37.14. The price though lower than total average cost but is higher than minimum of average variable cost 30. For this, the firm though incurs a loss in the short run but still continues production (Waldman & Jensen, 2016). The scenario however in different in the long run. In the long run the loss making firm exit the industry as price remain below the minimum of total average cost.
In terms of economics market represents an exchange relation between a single or group of buyers and sellers. The number of sellers in the market determines the degree of competition in the market. A perfectly competitive market is one where various buyers and sellers are present in the market and seller sell a homogenous good. In reality however no market is perfectly competitive (Sergienko, Mikhalevich & Koshlai, 2014). Some common form of imperfect competition is monopoly, oligopoly and monopolistic competition. Oligopoly and monopolistic competition are the two forms of imperfectly competitive markets found to exist in different countries.
The monopolistic competition is a kind of imperfect competition where several producers in the market sell a differentiated product. Because of product differentiation, the products are not perfect substitutes. Each firm in the market takes own decision regarding price and output keeping in mind prices charged by its competitors and cost of production (Fine, 2016). There is though large flow of information in the market but still the market lacks complete set of information like perfectly competitively market. Grocery market, coffee shops, hotels, automobile services are some examples of monopolistically competitive market.
The name oligopoly is derived from two Greek words, ‘Oligo’ meaning few and ‘Polein’ means sell. The oligopoly market thus refers to market where a few sellers engage in selling a homogenous or differentiated product. In case of homogenous product, it is called pure oligopoly while oligopoly market with differentiated product is called differentiated oligopoly (Nikaido, 2015). Airlines, petroleum industry, supermarkets, telecommunication industry generally have an oligopolistic market structure.
Consequences of an imposed tax on sellers
Relative size of the market and market control is an important factor differentiating oligopoly and monopolistically competitive market. Oligopoly market is smaller than the monopolistically competitive market. The few large seller in the market in the market thus have a greater control over price and enjoy a greater market power (Baiardi, Lamantia & Radi, 2015). In monopolistically competitive market large number of small sized firms have only a small market share and thus cannot influence market price.
Firms in an oligopoly market faces a kinked demand curve. The kinked demand curve has implication for price competition. When one firm reduces its price, its rival firms do the same. This leads to a price war among the firms present in the market. In Australia, Woolworth and Coles are the two dominating players in the grocery supermarket. If any one of them reduce price the other firms also reduces price of their products (Telser, 2017). Such price competition does not generally occur in case of monopolistic competition. Firms rather engage in non-price competition like product differentiation and advertising.
The oligopoly market generally represents a high barrier to entry in comparison to monopolistically competitive market. New firms can thus freely enter in a monopolistically competitive market. In the oligopoly market, government regulation often works as a barrier to entry. Other forms of barriers can be ownership of particular resources, high cost of research and development, limit pricing by the incumbent firms and others.
Presence of entry barriers has implication for long run profit. Barrier free entry of new firms in the monopolistic competition eliminates all the short run profit leaving only normal profit in the industry (Parenti, Ushchev & Thisse, 2017). In the oligopoly market because of high entry barriers the incumbent firms can sustain short run above normal profit.
Merges refers to the strategic practice of business where two organization joined hands to work as single entity. The three tiers of government in Australia are local councils, state government and federal government. The different levels of government often perform overlapping functions. Mergers between state and local government increases efficiency in the functioning of the government body by considerable cost reduction. The primary factors motivating mergers two levels of government are attainment of economies of scale, greater financial strength, increased capacity of government body, reduced cost of local government, high quality of services and efficiency gains (Greene, 2014). Some arguments for such government consolidation are discussed below.
Profit maximization condition
The first motivating factor for state government to merge with local government is the resulted economies of scale from a large scale operation. In the process of production, economies of scale are inferred as that stage of production where every additional unit of output is produced with a much lower average production cost (Drew, Kortt & Dollery, 2014). In context of government functioning, economies of scale are achieved when government faces a lower cost of goods or services offered to the public with increase in the given set of population served. When two government bodies merged then the large sized jurisdiction has a lower cost of offering the services. In the Australian state Victoria government amalgamation resulted in approximately 20% cost saving. The potential mergers of government bodies in Western Australia delivered a considerable cost saving along with securing a greater sustainability of the community (Fogarty & Mugera, 2013).
Another form of cost saving from merging is the potential economies of scope from producing a combination of goods and services. Economies of scope is not associated with increasing scale of operation. Rather it is associated with production of multiple goods. It is often observed that firms enjoy a cost advantage from producing a more than one goods. When State government merged with local government then services provided at the state level as well as at the community level are produced by the consolidated government body (Drew & Dollery, 2016). From jointly offering the service government enjoys a cost advantage in form of reduction in administrative and other overhead cost.
The local government because of their limited size does not have same level of expertise as state government does. When the two bodies of government merged then the efficiency of local government increases knowledge sharing among government officials. Access to a better skill along with economies of scope in turn improves the strategic capacity of the government. The merged government can then be able to make commitment for new functions which previously were not possible (Harman & Harman, 2008). The increased capacity in turn results in long term success of the government with a valued partnership within the system of government.
Mergers between local and state government have has long term implication in forms of a cost saving for administration and compliance. The administrative cost often imposes a great burden on limited government fund and affects efficient functioning of government. The administrative cost and other regular costs reduces significantly when government functions are undertaken by a single consolidated government. The evidence of merger in New South Wales reveals that the large organization is able to expand output by undertaking large scale projects as compared to former bodies of government (Drew & Grant, 2017).
References
Baiardi, L. C., Lamantia, F., & Radi, D. (2015). Evolutionary competition between boundedly rational behavioral rules in oligopoly games. Chaos, Solitons & Fractals, 79, 204-225.
Drew, J., & Dollery, B. (2016). Less Haste, More Speed: The Fit for the Future Reform Program in New South Wales Local Government. Australian Journal of Public Administration, 75(1), 78-88.
Drew, J., & Grant, B. (2017). Multiple agents, blame games and public policy-making: The case of local government reform in New South Wales. Australian Journal of Political Science, 52(1), 37-52.
Drew, J., Kortt, M. A., & Dollery, B. (2014). Economies of scale and local government expenditure: evidence from Australia. Administration & Society, 46(6), 632-653.
Fine, B. (2016). Microeconomics. University of Chicago Press Economics Books.
Fogarty, J., & Mugera, A. (2013). Local Government Efficiency: Evidence from Western Australia. Australian Economic Review, 46(3), 300-311. https://dx.doi.org/10.1111/j.1467-8462.2013.12015.x
Greene, R. (2014). Effective Rewards Strategies for Mergers, Acquisitions and Joint Ventures/Alliances. Compensation & Benefits Review, 46(5-6), 287-291. https://dx.doi.org/10.1177/0886368714565061
Harman, G., & Harman, K. (2008). Strategic mergers of strong institutions to enhance competitive advantage. Higher Education Policy, 21(1), 99-121.
Nikaido, H. (2015). Monopolistic Competition and Effective Demand.(PSME-6). Princeton University Press.
Norman, S., & Wills, D. (2017). The Importance of Emphasizing the Intertemporal Consumption Model in Intermediate Microeconomics. Journal for Economic Educators, (1), 25-29.
Parenti, M., Ushchev, P., & Thisse, J. F. (2017). Toward a theory of monopolistic competition. Journal of Economic Theory, 167, 86-115.
Perloff, J., Smith, R., & Round, D. (2013). Microeconomics (Australian Edition eBook). Melbourne: P.Ed Australia.
Sergienko, I., Mikhalevich, M., & Koshlai, L. (2014). Optimization Models in a Transition Economy. Boston, MA: Springer US.
Telser, L. G. (2017). Competition, collusion, and game theory. Routledge.
Tobacco taxes in Australia – Tobacco In Australia. (2018). Tobaccoinaustralia.org.au. Retrieved 21 April 2018, from https://www.tobaccoinaustralia.org.au/13-2-tobacco-taxes-in-australia
Waldman, D., & Jensen, E. (2016). Industrial organization: theory and practice. Routledge.
Order an Essay Now & Get These Features For Free:
Turnitin Report
Formatting
Title Page
Citation
Outline
