The article which I have chosen gives us a brief
idea about how the tax imposed on cigarettes affect their quantity demanded.
Now, cigarettes are a demerit good. Demerit good are those that are considered
undesirable for consumers, but are overprovided by the market. There are
various reasons for the overprovision for these goods but one of the most
prominent one is due to the ignorance of the harmful effects of these goods.
Therefore the market of cigarettes is an example of market failure, because
there is an over allocation of resources instead of a balanced allocation of
Now, an indirect tax imposed on the cigarettes would
cause the MPC to shift upwards thus reducing or eliminating the welfare loss.
Thus, if the Tax imposed is equal to the Negative externality, the welfare loss
will be eliminated. Because the MPC has shifted upward, the price of the good
will become higher. For the producer, the revenue/surplus decreases. The
government receives a higher revenue because, the amount of Tax multiplied by
the number of units has increased. We need to note that, here an Indirect tax is
imposed to create allocative efficiency
whereas it is generally imposed to create
allocative inefficiency. Allocative efficiency is a state of the economy in
which production represents consumer preferences; in particular, every good or
service is produced up to the point where the last unit provides a marginal
benefit to consumers equal to the marginal cost of producing.
Cigarettes have a very unique nature, i.e. they have
a highly inelastic demand. This is because they are addictive goods in the short
run. Their consumers will continue buying it even if there is an increase in
its price. Due to the nature of cigarettes, they affect the Tax incidence. Tax incidence is defined
as the amount of the burden of the tax that is shared between the consumers and
producers. The tax incidence is directly
related to the PED (price elasticity of demand). It is a measure to show the
responsiveness of a certain quantity demanded of a commodity or service to a
change in its price, ceteris paribus. When the PED of a certain good is higher,
i.e. it is inelastic, then most of the Tax incidence is on the consumers.
Therefore, in this case too, the tax incidence is on the consumers of the
cigarettes. The reason is that the consumers are unresponsive for the changes
in price. The tax incidence is calculated by multiplying the increase in price
by the number of units. As seen in the diagram below the tax incidence on
consumers is higher than the incidence on the producers.
Disadvantages of imposing an indirect tax:-
Living standards of Consumers become low: The increase in
the price of the Cigarettes causes the consumer to buy the good because it is
addictive. This causes a decrease in their total disposable income and thus
lowers their living standards.
Tax is a form of regressive tax: Indirect tax is a tax
in which the consumer has to pay a fixed amount of tax no matter what their
income is. For example; A Tax of $2 is imposed on the cigarettes, this Tax may
be less for rich people but it might be a lot for poor or middle class people.
This causes a rise in income inequality. Furthermore, a large percentage of
smokers belong to the lower and middle class of people.
Consumption of cigarettes is not largely affected in the short run: Cigarettes
have a relatively high inelastic demand thus, their consumption may not
decrease in a short period of time. The consumption may decrease in the long
run because consumers get time for changing their habits.
of Producer revenue: The increase in the price of the
cigarettes causes a decrease in the revenue of producers. Due to this the
producers may face opposition by the labourers for a decrease in their wages.
This may cause an increase in the unemployment.
Advantages of imposing an indirect Tax:-
government revenue: Because the PED is low, i.e. the
reduction in demand is low, the government earns a higher revenue. The
government can use this revenue to fund the production of merit goods. Merit
goods are those whose demand is high but are underprovided by the suppliers.
in smoking in the long run: The indirect tax
imposed on cigarettes causes the consumers to change their consumption habits
over time. This is because the total amount of disposable income of the consumers
becomes low over the time.
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