Question

(i) Draw the demand and supply curve for the illegal cigarette market in Australia. (ii) What assumptions have you made about the demand and supply elasticities in the illegal market when compared with the legal market? (This question is based on the article: “Fighting the ‘Up in Smoke’ gangs,” John Silvester. The Age. Saturday, December 16, 2017. Page 38.)

Comments: I understand the 'legal' cigarette market within Australia, in this case I believe that demand is elastic as consumers are responsive to price changes in the illegal market ($14 for a pack of 25 cigarettes within illegal market compared to $32 on the legal market). Consumers (who are willing to purchase illegal cigarettes line up to purchase more cigarettes) purchase more at this price as supply is limited. I have drawn what I believe is correct but would like advice on if I am interpreting & analysing this correctly.

Answer 1

The illegal trade of tobacco is driven by both supply and demand. Consumers try to evade taxes and suppliers desire to make high profits , easy entry in the border etc are leading causes of growth of illegal market in Australia .Illegal cigarettes are cheap and do not have health warnings . Increased tobacco taxes which increase the price do not stop consumers from smoking and they shift to illegal market.Low cost of production which makes price low and higher demand make the illegal market strong. Australia's attempt to bring down smoking through higher taxes has only led to the growth of illegal cigarette industry and loss of revenue to the government.Higher taxes increase the price and reduces consumption.. Smokers who are price sensitive move to the illegal market where price is less Thus illegal cigarette market in Australia grew because of taxation in the legal market.

There are many factors on which price elasticity depends but the most important factor is tthe availability of substitutes .When the consumer can move easily to another product when price increases elasticity is higher.This happens when price rises in the legal market due to taxation and consumers shift to the illegal market where cigarettes are cheaper.