Question

CASE 2. ELASTICITY

In the United States, taxes are imposed on cigarettes at the state level. As a result, there are large differences among states. As of July 1, 2010, three states had cigarette taxes in excess of $3.00 per pack: Rhode Island, Connecticut, and Washington. Seven more had rates between $2.00 and $3.00 (including the District of Columbia). Missouri had the lowest rate among the 50 states at $0.17 a pack. The following article describes a proposal to raise taxes by $1.00 per pack in the state of Washington. We would expect an increase in the tax on cigarettes to increase their price to consumers. An interesting question from the point of view of health and tax revenue is how much a price increase lowers demand. One of the commentators in the article claims that increasing cigarette prices by 10 percent reduces youth smokers by 6–7 percent; this is an implied demand elasticity of –0.6 (6%/10%). How do you think this compares to what we would expect from adult smokers? Many people would argue that because more young people are new smokers and because they have less money than adults, their demand for cigarettes would be more elastic. On the other hand, if peer pressure favors smoking, this could lower demand elasticity for youths. One problem that states face as they increase their cigarette taxes is that people will seek cigarette substitutes from cheaper areas. In Washington, the state pressured Indian tribes to raise the tribal tax rate on cigarettes to the overall state level. By making these substitutes to state-taxed cigarettes more expensive, the loss of customers in response to the state tax increase would be less.

Question: Analyze the given case and find that who Are the Elastic Smokers? Provide justification to you answer.

Answer 1

The government should take elasticity of demand into consideration when deciding whether to increase or add an excise tax levy.

If we take this case of US where there arises to whether to impose taxes on cigarettes, if the price elasticity of demand is inelastic i.e. it is below 1, then the increase in tax brings about a decline in consumption and increase in total tax revenue that would be collected by the state.

Talking about the elastic smokers i.e. the smokers who have cut on their consumption of cigarettes due to increase in price caused by increase in taxes imposed on them.

Price and Consumer Disposable Income are the two major determinants of the demand for cigarettes.
-> Increase in the price cause cigarette consumption to decrease irrespective of the income status of the state they belong to.
-> Increase in income may lead to increase in cigarette consumption particularly in low income settings.

Increase in the price of the cigarette are followed by moderate falls in both the percentage of the people smoking and the amount or say number of cigarettes that remaining smokers consume.

The percentage of people smoking declines because tax increases which discourages non smokers from using again. This is because increase in cigarette tax results in higher cigarette prices for everyone, though the price elasticity of demand is inelastic but the effect of even small resulting reductions in cigarette use can be very large across the whole population.

But taken into consideration that the cigarette price elasticity is inelastic and that the reduction of the cigarette consumption is done with the strategy of raising domestic cigarette price by raising taxes by the government, it is concluded that the cigarette price needs to be quite high in order to lower the consumption.

We should also take into notice that income also plays the role of a major determinant behind the consumption of any XYZ product and same is here in the case of cigarettes. In the case of cigarettes income elasticity of demand was positive which indicates that cigarettes were normal goods. It means that the demand for cigarettes would increase if the income increases.

Now taking the price elasticity and the income elasticity factors into consideration and their affect on the consumption of cigarettes, let us conclude who are the smokers who are actually inelastic.

1. Basically the youth, i.e. the young smokers or say the students who are new to smoking or who have just started practicing smoking will easily lower their consumption.

2. If we talk of adults then the adults with lower income or without any income or light smokers will be found to be sensitive to the changes in cigarette prices.

Thus, It can be concluded that the factor that influence the price elasticity of demand for cigarettes is income level. For people who will have higher income will buy cigarettes even when their price is high( since income is normal good), but for those who have the lower income will be affected by the price. For the people that age 15-23 years, they will buy less cigarettes by cutting on their demand because cigarettes are now high priced but the people aged 24-29 they will be okay to buy cigarettes even when the price is high.