Microeconomics Analysis on Cigarette Tax

http://biz.thestar.com.my/news/story.asp?file=/2008/11/11/business/2511463

http://thestar.com.my/news/story.asp?sec=focus&file=/2012/9/21/focus/12058559

http://biz.thestar.com.my/news/story.asp?file=/2012/2/17/business/10753033&sec=business

http://biz.thestar.com.my/news/story.asp?file=/2013/4/26/business/13025915&sec=business

http://www.dailymail.co.uk/sciencetech/article-2012023/Have-scientists-finally-created-safe-cigarette.html

The articles extract above is to observe the impact of tax imposed by the government. Different microeconomic concepts are used to analyse these articles. The main intention of government charge higher price of cigarette is to cut down the quantity of smoker from being increases. Cigarette is one of the negative externality as it could cause pollution. Therefore, the objective of government is to impose tax on it. They plan to reduce the number of smoker as cigarette not good for health. According to the World Bank Report (1999) it states that tobacco tax should be charged up from 67% to 80% of dealer cost. This is because the Health Ministry's 3rd National Health and Morbidity Survey (2006) announced that there are 3million of smokers exist in Malaysia which comprised of 30.9% of boys ages between 13-15 and  23.1% of adults (Consumers Association of Penang, n.d.). Increased tax will help to reduce the percentage of people smoking. This could increase the government revenue but the main reason of imposed tax is to reduce the pollution and increase the health living of citizen.

The inelastic demand curve in graph 1 above shows that the change in price leads to a less than percentage change in quantity demanded. According to law of demand, the price and quantity demanded has the inverse relationship while other factors are remain unchanged. When the price of cigarette increases, the quantity demanded will decreases. This is due to the willingness of smokers to purchase decreases and they are unable to afford it. This will lead to decrease in quantity demanded. However, supplier would be much happier to supply more cigarettes in order to maximize profit. This has proven by law of supply as it shows the positive relationship between price and quantity supplied while other factors are remains unchanged. When the price of cigarette increases, the quantity supplied will increases.

Furthermore, income effect and substitute effect occurs when price of cigarette rises. When the income of smoker remains the same while the price of cigarette continue to rise, the smoker cannot afford the cigarette consumption as much as they previously brought. So, they will purchase less and causes the quantity demanded of cigarette falls. For those smokers who are hardly quit smoking, they will find substitution for it where substitute effect sets in. The electronic cigarette (e-cigarette) is a substitution of cigarette. It is a battery-powered device which filled with liquid nicotine in it. It has the same smell of cigarette and it is less harmful compared to cigarette. It is less harmful as it can help the smokers to kick the habit. Meanwhile, the changes in the price of cigarette influenced the price of complementary goods which is the lighter. The quantity supplied of lighter decreases in response to the decreasing needs of cigarette in the market. This is because people will not buy lighter if they have quitted smoking.

Price elasticity of demand (PED) is to measure the elasticity of the quantity demanded to a change in the good’s price. Cigarette is considered as inelastic demand because the price of cigarette increases gradually but people still continues purchasing cigarette. There are several ways that lead to inelasticity of demand. Substitutability is one of it because if an item has fewer substitutes, it tends to have less elastic demand. The substitution mentioned above which is e-cigarette is not a good substitution for low income earner since e-cigarette is much more expensive than cigarette. That is why less people switch to e-cigarette. Besides, the habits of smokers are hardly to quit since they have addicted to it. The smoker will undergo the physical withdrawal symptoms while quit smoking such as sniveling, coughing, headache, muscle cramp and etc. At the same time, they will get anxious, irritable and depress easily for no reason (quicksmokingsupport, 2013). In fact, the smokers will face a hardship during that time. Thereby, smokers need to have a strong willpower in order to quit smoking effectively. These factors results the smokers tend to have inelastic demand for cigarettes.

Price floor occurs when the government set a price higher than market equilibrium. The intention of government of setting price floor is to remove the habit of smoking as it harms people’s health. From the graph 2, the minimum price of cigarette that set above equilibrium price creates a surplus in market. This is because the supply exceeds the demand. There will be a market failure where the inefficient underproduction happened in market. Price floor will not have a big variation to the quantity demanded as the cigarette is an inelastic product. Tax incidence is the tax burden between producer and consumer. In my knowledge of microeconomics, the consumer will pay the tax provided the product is inelastic and vice versa. As the producer cannot charge the price lower than minimum price, the consumer have to pay more for it. People with lower income will seek for black market to get cheaper cigarette to satisfy their needs.

In Malaysia, the minimum cigarette price in past few years is RM6.40 in cigarette pack of 20s which is relatively low in an anti-smoking country. However, this scenery has changed over the years. According to British American Tobacco Malaysia (BAT Malaysia), the price of cigarette will increase 20sen and it has effectively on 22 October 2012. The point of P₀ and Q₀ is the market equilibrium at 2011. After the government impose tax on cigarette, the price of cigarette increases from P₀ (RM10) to P₁ (RM10.20) per pack. It is not a movement in the supply graph as the willingness of supplier to produce the cigarette decreases. This is due to the increase in cost of production and eventually shifts the supply curve leftwards. The cigarette is considered as necessity for a smoker thus the change in price will not affect much on hardcore smoker.  Smokers are willing to buy it regardless of how much it cost them. However, some smokers will cut off smoking if they cannot afford it. In other word, the imposing tax in cigarette increases the household disposable income which further increases their burden.

The orange box between P₀ and P₁ is represents as consumer burden while purple box between P₁ and P₂ is represents as producer burden. This shows that the consumer burden is greater than producer burden. As the price increases, the producer will charge higher price on customer so as to cover their cost of production. As a result, producer burden has shifted to consumer burden. In short, the smoker paid the largest tax rather than producer. The yellow triangle is indicating deadweight loss which is the loss in society. The black market occurs brings deadweight loss to the market. If the price is too high, smoker will search for party who sell cheaper cigarette in black market. The ratio of cigarette sold on the black market has increased from 15% to 36.6% from year of 2009 to 2011. Normally, the black market could sell cigarette at cheaper price which is below the minimum price of cigarette.  According to Global Adult Tobacco Survey (GATS), smokers tend to switch to the illegal cigarette as the amount of smokers in Malaysia does not reduce. It shows that smokers still do not quit smoking. GATS further explained that nowadays smoker spent too much on cigarette which around RM6 per day or RM178.80 per month on average. When the orange box combines with purple box, it is known as government revenue. In other word, government revenue increases when tax increases.

Imposed tax on cigarette doesn’t  reach the government’s goal but eventually cause the people even poorer. The high cigarette tax could reduce the consumption of smokers with low income but majority of smokers are likely to reduce in other expenditure to afford it. Hence, the main reason of decreasing in number of smoker is due to the health condition instead of high price of cigarette. In my opinion, the impose tax on cigarette doesn’t work effectively to reduce the amount of smoker. It will leads to negative effect to the society if the tax of cigarette imposed is too high. For example, the society crime rate will increase, selling illegal cigarette everywhere and etc. A reasonable price of cigarette will improve the living standard and health condition of citizen. The research shows that the majority of smokers are teenager rather than adult. In order to remove this habit, the government should take into account that the reasons of people start smoking at young age. This may due to the family problems or environment that they have been grown up. Therefore, parents should pay attention to their kids and be their role model by not to smoke. For government side, anti-smoking campaigns can be carried out so that the people are aware of dangers of smoking. The regulation of selling cigarette also should be enforced.