Question 1
An elasticity of demand is a representation of the extent of change in demand. If the price for a good changes, there will a change is demand depending on the type of a good. For a normal good, there is a fall in demand when the price increases and a rise when the price decrease. For an inferior good, the demand for a good be rising when the price is rising or fall when the price is falling. However, for some goods, the change in demand is insignificant while the change is very high for others. For necessity goods, the changes in demand owing to price changes is insignificant since people cannot do without such goods. Alcohol is considered a demerit good since its consumption is harmful to one’s health and destructive to the economy as it causes negative externalities (Hoffer, Shughart II, & Thomas, 2013). The government therefore decides to implement policies towards its consumption reduction, those who indulge in its consumption accept a tax increment as a legitimate punishment for its intake (Sadowsky, 2010). The government is therefore able to raise more revenue in additional to live saving. This paper will be very important to the distributors of alcoholic products in assisting them in price making decisions. The policy makers will also use it to determine whether the desirable results could be achievable to the economy.
An excise tax imposed on alcohol (a demerit good) is referred to as a sin tax (Sadowsky, 2010). The main goal of this imposition is to try and reduce it overconsumption. Chen, Matovu & Reinikka-Soininen (2001) noted that this is an indirect tax since it is only payable by those who consume the good. Those who do not consume alcohol are not liable to pay this tax. Alcohol has been recorded as one good that reduces the economic productivity of a person especially those who overconsumes it. The case on hand is hereby determining the issue of tax incidence where tax is divided between the supplier and the consumer. The division is not on an agreeable terms but on the price elasticity of demand. Most of the times, the suppliers are the decision makers and therefore set the prices for the goods they supply. Because of this, they always tend to transfer the whole tax burden to the end users. The price set by the suppliers after a tax imposition is higher and in some cases may take into account the total tax increment such that the supplier suffers no cost increment, but the consumer pays the whole tax imposed.
Minimum Pricing of Alcoholic Products
However, it is not in all cases that the supplier is able to transfer the whole burden to the consumers. Depending on the elasticity of the demand to price changes, the consumer may be even totally unable to transfer any of the imposed tax to the consumers and ends up suffering the whole tax burden. When the price elasticity of demand is more than one (meaning that the demand is elastic to price) the supplier is not able to charge higher prices as this will result in a huge decrease in sales and subsequently the gross profit. However, when the price elasticity of demand is less than one (meaning that the demand is inelastic to price changes) the whole burden is transferable to consumers through higher prices. The following diagram provides the price elasticity of demand estimates for alcoholic products.
Graph: PED for alcoholic products
Source: (Thapa, Solomon, & Boumphrey, 2014): Euromonitor International’s Industry Demand Model
The graph above shows that PED for total alcoholic drinks is between – 0.4 and – 0.5. The negative sign is an indicators that the relationship is negative. Ornstein & Levy (2017) noted that such elasticity estimates vary from country to country. Since the elasticity is less than one, alcoholic drinks can be considered to be price inelastic. Meaning that a price increment won’t have a significant change in the quantity demanded. This enables the suppliers to charge higher prices on such drinks since there is no worry that the demand will fall. This include tax transfers to the consumers. For the results to be used in different countries, the country should first estimate its own PED. The study is based on the total estimate of alcoholic drinks. However, the policy makers should understand that the implementation of a tax would only be effective to the individual types of alcohol which are price elastic (PED greater than one). For the inelastic ones, the policy won’t result in a significant change. The diagram below shows the actual bearer of a sin tax.
Graph: Tax incidence when demand is inelastic
The diagram is an indicator of how the supplier shift the tax burden to the end users. Since a big change in price will result in a small change in demand, the suppliers are better off. The price before tax is P, quantity demanded is Q and supply is S. The after tax price is P1, quantity demanded Q1 and supply is S + tax. The proportionate fall in Q is less compared to proportionate increase in P. The burden on consumers is very high compared to that of producers. This graph is for the total alcoholic drinks in general, and also for the individual specific alcoholic products. However, for individual alcoholic products which have an elastic demand, the graph is as follows;
Comment
Graph: Tax incidence when demand is elastic
The difference between this and inelastic tax incidence graph is that the change in demand is very high compared to a small change in price. The supplier therefore is not able to charge higher prices and end up suffering a greater tax burden as can be observed from the diagram.
Minimum pricing involves the government setting a price above the normal equilibrium below which the products cannot be sold. The following graph shows how the economy is impacted by a minimum pricing policy.
Graph: Minimum price imposition on alcoholic products
Source: Amir (2016)
The equilibrium point is (PQ). Price P before the minimum pricing is lower. A price P1 (minimum set price) is higher than equilibrium price; therefore, the demand will fall to Q1. A higher price P1 will create a higher supply for alcohol products creating a surplus equal to Q2 – Q1 (Pettinger, 2011). To create a bigger market for the excess supply, the suppliers may opt to sell at a black-market price which are lower than the minimum price. This creates a challenge for the policy makers.
An exercise tax is better since it is easier for the policy makers to estimate the possible effect that the prices resulting from new tax imposition will have on the market. For the minimum pricing, there is no basis in which this estimates could be made. It is also a greater advantage since in addition to controlling the consumption, the government is also raising revenue that could be used for other government spending. For the minimum tax no revenue is raised by the government. An excise tax will result in better results than the minimum pricing since there is no chance for practicing a black-market business since the government tax has to be paid. For minimum pricing, black-market business may hinder better results. Excise tax policy is cheap than the minimum pricing since it doesn’t require monitoring as is the case for minimum pricing.
Part A
Graph: Short run and long run monopolistic competition
If the graph above is used to represent the demand and price for tables, it can be seen that both in the short and in the long run, the price is above the minimum point of the ATC. Therefore it can be concluded that the price for tables will be above $ 200 in the long run. This is because the point of tangency showing equilibrium in the long run is before the minimum long run average cost; the demand curve is sloping downwards though it is elastic in nature. It therefore can never be tangent to the minimum point of the u-shaped LRAC.
Question 2
Part B
The oligopolistic market characteristics are; (i) the participants are many but there exist a few large firms who dominate the market (Welch & Welch, 2016); (ii) the products sold by the participants may either be differentiated or identical; (iii) barriers to entry makes it difficult for new entrants into the industry, they include high costs of financing and the need for a big business to stand the competition. Three examples of oligopoly industry in Australia include; (i) the supermarket industry where Coles and Woolworths dominate the market (Andrew, 2014); (ii) the telecommunication industry where Telstra dominate the market (Havyatt, 2010); and lastly the Insurance industry where Uncorp and IAG’s dominate the market (Smith, 2015).
Part C
The characteristics for monopolistically competitive market include; (i) the buyers and sellers are many; (ii) the products are differentiated but are close substitutes; (iii) firms have partial prices controls; (iv) minimal entry or exist barriers (Hall & Lieberman, 2010); (v) cost is incurred on differentiation (e.g. advertising); and insufficient information on market conditions (Chand, 2017). Three examples of monopolistic industry in Australia include; (i) the coffee industry where firms are many, free entry and exit, similar goods and services produced and own price control (Muller, 2012); (ii) Hair dressing business where sellers and consumers are many but the services are differentiated for similar products; (iii) and the food shops that offer different quality of services with no entry barriers.
Part D
The conditions for a natural duopoly to occur are; there must be two major firms that can meet the whole economy’s demand. There are two types of duopoly; the Cournot and Bertrand duopoly. For the Cournot duopoly to exist, the competition between the two firms must be product-based. The strategy adopted by the two firms is that of splitting the market where the product produced by each determines the price each gets (Investinganswers.com, 2017). For the Bertrand duopoly to exist, the competition must be price-based where they two firms cut prices to attract more customers making their equilibrium prices and profit to be low.
Graph: Natural duopolies economies of scale
The natural duopoly prevents others from surviving in the market. The market demand Q is met by two firms. A single firm achieves an economy of scale equal to Qo. The production level is at the lowest point of the ATC curve and this is the lowest possible price. According to Parkin (2015), the economies of scale won’t be experienced by the new firms into the markets and this explains why there is resistance to entry.
References
Amir. (2016). Maximum and minimum prices. Economicsguide.me. Retrieved 12 April 2017, from
https://www.economicsguide.me/?page_id=2529.
Andrew. (2014). Australian Oligopolies. Blog.adonline.id.au. Retrieved 13 April 2017, from https://blog.adonline.id.au/oligopolies/.
Chand, S. (2017). 7 Most Important Features of Monopolistic Competition. YourArticleLibrary.com. Retrieved 13 April 2017, from
https://www.yourarticlelibrary.com/economics/7-most-important-features-of-monopolistic-competition/9154/.
Chen, D., Matovu, J. & Reinikka-Soininen, R. (2001). A Quest for Revenue and Tax Incidence in Uganda, Issues 2001-2024. International Monetary Fund.
Economicsonline.co.uk. (2017). The incidence of an indirect tax. Economicsonline.co.uk. Retrieved 12 April 2017, from
https://www.economicsonline.co.uk/Competitive_markets/Tax_incidence.html.
Hall, E. & Lieberman, M. (2010). Economics: Principles & applications. Mason, OH: South-Western Cengage Learning.
Havyatt, D. (2010). The structure of the telecommunications industry after thirteen years of competition. Australian Policy Online. Retrieved 12 April 2017, from
https://apo.org.au/node/69130.
Hoffer, A., Shughart II, W., & Thomas, M. (2013). Sin Taxes: Size, Growth, and Creation of the Sindustry. Mercatus.org. Retrieved 12 April 2017, from
https://www.mercatus.org/system/files/Shughart_SinTaxes_v2.pdf.
Investinganswers.com. (2017). Duopoly Definition & Example | Investing Answers. Investinganswers.com. Retrieved 13 April 2017, from
https://www.investinganswers.com/financial-dictionary/economics/duopoly-1315.
Muller, L. (2012). Monopolistic Competition: Coffee Industry. Prezi.com. Retrieved 13 April 2017, from
https://prezi.com/i4vsfq5trnrf/monopolistic-competition-coffee-industry/.
Ornstein, S. & Levy, D. (2017). Price and income elasticities of demand for alcoholic beverages. Ncbi.nlm.nih.gov. Retrieved 12 April 2017, from
https://www.ncbi.nlm.nih.gov/pubmed/6390555.
Parkin, M. (2015). Microeconomics + myeconlab with Pearson etext (12th Ed.). [Place of publication not identified]: Prentice Hall.
Pettinger, T. (2011). Price controls – advantages and disadvantages. Economicshelp.org. Retrieved 12 April 2017, from
https://www.economicshelp.org/blog/621/economics/price-controls-advantages-and-disadvantages/.
Sadowsky, J. (2010). The Economics of Sin Taxes. Acton.org. Retrieved 12 April 2017, from
https://acton.org/pub/religion-liberty/volume-4-number-2/economics-sin-taxes.
Smith, M. (2015). The death of the oligopoly: Australia’s incumbents face new rivals. Financial Review. Retrieved 13 April 2017, from
https://www.afr.com/brand/chanticleer/the-death-of-the-oligopoly-australias-incumbents-face-new-rivals-20150421-1mq11b.
Thapa, R., Solomon, D., & Boumphrey, S. (2014). Price Elasticities in Alcoholic Drinks. Euromonitor International Blog. Retrieved 12 April 2017, from
https://blog.euromonitor.com/2014/08/price-elasticities-in-alcoholic-drinks.html.
Welch, P., & Welch, G. (2016). Economics (11th Ed.). Hoboken, NJ: John Wiley & Sons, Inc.
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