The news reported that the United States government is
increasing the indirect tax by 13 percent.
Cigarettes are goods which create negative externality when they
are consume because emission of second hand smoke causes lung cancer, bronchial
illnesses and asthma, these are spillover costs that go beyond consumers and
have to be paid by third parties who are not involved in these actions.
As implied by the
article, “People who smoke presumably enjoy some private benefits of smoking,
but this will create external costs for other people.” This implies that the social
benefits of consuming cigarettes given by marginal social benefit (MSB) are smaller
than the smoker’s private benefit given by marginal private benefit (MPB) because the external costs of second hand
smoke are not taken into consideration by consumers. The MPB curve represents
demand and intersects marginal social costs (MSC), which determines a higher
equilibrium point at a level of output for cigarette (Q1) that is greater
than the social optimum (Q*) and a price (P1) that is
more than the social optimum (P*).
The divergence between MSC and MSB for the amount of cigarettes (Q1
– Q*)is the welfare loss shown by the blue triangle
representing a reduction in social benefits due to overconsumption of
cigarettes and reflects the failure of the market to achieve allocative efficiency.
The effect of cigarette indirect tax is a parallel upward shift
by the amount of tax added to cigarette producers from the supply curve MSC to
MSC + tax, this leads to a new equilibrium where MSC+ tax equals to
MSB. Many governments were having
indirect taxes that were “reducing the supply and consume of cigarettes”
because firms experience higher operation cost which discourage investment in
cigarette production, this will lead to a decrease in equilibrium quantity of
cigarettes from Q* to Qtax. Due to under supply at the original
equilibrium, a upward pressure is induced on cigarette price from P1
to P2 which causes “the rise in cigarette prices over the past
year”, thus on the cost of consumption for smoker. In reality, cigarettes indirect tax is reducing
the problem of second hand smoke because MPC is shifted further away from MSC,
hence moving the equilibrium quantity and price closer to the social
optimum. Since MPC is now even greater
than MSB for all quantity of cigarettes greater than Q*; therefore,
the deadweight loss is decreased to the orange triangle, representing a smaller
loss of potential welfare to society.
There are a number of options for the government to reduce or eliminate
the negative externality of smoking but there are pros and cons for any option
The government could simply ban cigarette smoking totally- make
it illegal to smoke.
However, this is not so simple, since this would have a large
effect upon tobacco industry, in terms of shareholders and employment. Governments also make a lot of revenue by
taxing cigarettes, which have price inelastic demand, because they are
habit-forming. Also, it must not be
forgotten that governments need votes and smokers are not likely to vote for a
government that bans smoking.
The government could impose indirect taxes on cigarettes, as
However, the inelastic demand for cigarettes tends to mean that
taxes do not manage to reduce the quantity demanded very much and so, while
government revenue is raised, quantity demanded does not fall to the socially
efficient level. The reason why the
governments haven’t raise the tax too much is because people might start to
look for other sources of supply.
Smokers might go to other countries where cigarettes are cheaper and
purchase large quantity. This process is
illegal and black market will be formed.
The government could provide education about the dangers of
smoking and also fund negative advertising in order to reduce demand for
cigarettes, thus shifting the MPB curve to the left. However the costs of this may be high,
although if taxes are in place, then the revenue could be used to fund these
measures. Also, there is doubt as to the
effectiveness of education and advertising in terms of reducing cigarette
consumption. Many teenagers smoker seem
prepare to accept the dangers of smoking and are little affected by measures to
put them off.
Overall, there are pros and cons for any option for the
government to reduce or eliminate the negative externality of smoking but. The best solution is a policy which includes
all three options so that all the advantage of those options could be taken.