Running Head: Price Elasticity of Demand and Tax on Tobacco

Price Elasticity of Demand and Tax on Tobacco

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Introduction:

A. In order to reduce the number of consumers of tobacco products policy measures will be to tax on tobacco, however the impact of this tax will be determined by the price elasticity level in the economy, the following is a discussion of the importance of price elasticity of demand in the tax on tobacco.

Tobacco taxes in the UK:

Tobacco tax in the UK has increased over the years, data collected from the tobacco manufacturers association (2009) shows that in 1990 the amount of tax per 20 cigarettes amounted to 1.2 pounds while in 2009 the tax had increased to 4.34, the following chart summarises taxes over the years:

The above chart shows an increase in the level of tax per 20 cigarettes for the period 1990 to 2009. However according to the ACT on tobacco and health state that despite this increase in taxes, tobacco taxes are only adjusted in line with the rate of inflation and therefore have no major effect on tobacco consumption.

Tobacco taxes are imposed for various reasons, these taxes are imposed in order to reduce tobacco use in the economy and therefore improve public health. However the price elasticity of tobacco is an important factor to consider when imposing the tax in order to determine whether the price increase will reduce consumption to the desired level.

Price elasticity of demand:

Price elasticity of demand refers to the decline in demand when the prices are increased, the price elasticity value identifies the sensitivity of demand to a price change, price elasticity value of negative one means that a 4% increase in price will increase reduce demand by 4%, a value greater than negative one example -0.05 means that the demand is price inelastic while a value less than negative one example -4 means that we have relative elasticity, the following diagram demonstrates the nature of these demand curves that are inelastic, unitary and elastic. (Gregory Mankiw, 2002)

From the above diagrams it is evident that in diagram one a price increase by one from price 1 to price 2 will reduce demand by one unit from quantity 2 to quantity 1, the price elasticity value here will be -1 and therefore we have unitary elasticity.

According to the World Bank the price elasticity of tobacco demand is less price sensitive in developed countries than developing countries, and tobacco demand curves are price inelastic given that a 10% increase in prices will only reduce demand by 4% to 8%. According to the World Bank report a 10% increase in prices of tobacco in developed countries reduced demand by only 4% while in developing countries a 10% increase in prices of tobacco reduced tobacco demand by 8%. Therefore in developed countries accounting to this report the price elasticity of demand is -4/10 = -0.4 while in developing countries the price elasticity of demand is -8/10 = -0.8.

Further research by the World Bank showed that among the youth and the poor a 10% increase in prices of tobacco reduced the demand by 10%, this is unitary elasticity meaning that increasing the price by one unit will reduce demand by one unit, this therefore means that the tax on tobacco is more effective among the youth given that a higher tax deters the youth from tobacco consumption.

Importance of the price elasticity of demand:

From the above analysis it is evident that the price elasticity of demand is important in determining the significance of the tax on tobacco, the value of the price elasticity of demand of tobacco will determine the decline in demand when a tax is imposed, from the above it is evident that the price elasticity of demand for tobacco is inelastic and this means that increasing the price by imposing a tax will reduce demand by a lower percentage than the percentage increase in price. (McConnell and Brue, 1999)

The price elasticity of demand level is important in determining the impact of the tax on the economy. Tobacco taxes have certain consequences to the economy. Some of these consequences include reduced tax revenue, increased smuggling, improved public health, impact on the poor tobacco consumers and job loses.

Given that tobacco price elasticity of demand is inelastic then this hurts the poor consumers, The percentage of income spent on tobacco products is higher for the poor individuals in the economy, an increase in taxes will result into higher prices meaning that the poor are more hurt in that they will be required to spend a higher percentage of their income to purchase these products.

Price elasticity of demand value will also determine the decline in demand for tobacco, higher decline in demand will lead to reduced tax revenue, taxes include value added taxes on the product, profit taxes that are imposed on tobacco firms and income taxes imposed on employees of tobacco firms, therefore increasing the tax that result into a decline in demand leads to reduced tax revenue collected by the government.

Elasticity will also determine the employment changes in the economy, according to the tobacco manufacturers association tobacco firms employ over 5,176 employees and employs over 80,000 indirectly including suppliers and distributors, depending on the price elasticity value a tax that results into a large decline in the demand level profit levels of tobacco firms are likely to decline reduced and firms will tend to lay off workers as their profits reduce due to the tax imposed, this results into job losses in the tobacco firms and this reduces the level of per capita income. However if tobacco consumers quit smoking and spend their income on other goods and service, then the tax will lead to increased employment in other sectors of the economy.

The tax value will be determined using the price elasticity of demand, policy measures aimed at reducing demand by a certain percentage will be determined using the price elasticity value, the price elasticity value will help in determining the appropriate tax value that increases prices to the desired level in order to reduce consumption.

Conclusion:

From the above discussion it is evident that the price of elasticity of value is an important measure of the changes that will occur when a tax is imposed on tobacco products, this value is important in that it can help in determining the appropriate tax value that should be imposed in order to reduce tobacco consumption. Taxes on the other hand should be fair and depending on the price elasticity value of tobacco products certain groups in the economy may be unfairly taxed whereby poor individuals in the economy may have a greater tax burden than higher income individuals.

References:

Act on Smoking and Health, 2009. Tobacco taxes, Retrieved on 7th November, from

BMA, 2008. EU and tobacco taxes, retrieved on 7th November, from

Campbell McConnell and Stanley Brue. Microeconomics: principles, problems, and policies. New York: McGraw Hill press, 1999.

Gregory Mankiw. Principles of microeconomics. New Jersey: Prentice Hall press, 2002

Tobacco Manufacturers association, 2009. Tobacco taxes and employment, retrieved on 7th November, from

World Bank, 2008. Tobacco taxes, elasticity and impacts, retrieved on 7th November, from

UK Statistics, 2009.General household, retrieved on 7th November, from Survey,http://www.statistics.gov.uk/ssd/surveys/general_household_survey.asp