The market economy is defined
as a convenient arrangement in which buyers and sellers, motivated by
self-interest, can communicate with each other in order to exchange goods,
services or factors of production at an agreed price. Buyers as a group determine
the demand for the product, whereas the sellers as a group determine the supply
of the product. Demand and supply as a whole determine the market price and
quantity demanded and supplied. Markets respond to change and also to create
change.
Demand is the amount of goods consumers desire and are willing to buy in a given period of time at a given price, ceteris paribus. Many factors can affect the buying decision of the buyer such as prices of related products like substitutes, complements and more. In addition to this, there is a unique relationship between price and the quantity demanded of a good. The law of demand states that in a given period of time, the quantity demanded of a product is inversely related to its price, ceteris paribus (Sloman et al., 2012).
According to the article, it shows that the government should raise the cigarettes price from RM10 to RM30 in order to reduce the consumption of cigarettes (Idris, 2012). In the United States, the consumption of cigarettes is reduced after increasing the price of cigarettes. This clearly shows that the higher the price of a good, the less the willingness and ability of consumers to buy the good, and hence the smaller the quantity demanded. Therefore, the quantity demanded of cigarettes in Malaysia should decrease when the price of cigarettes increases. The factor affecting the decrease in demand of cigarettes is mainly because of the lower price of its substitute.Since the opportunity cost for cigarettes becomes too high after the raise in its price, people will seek for cheaper alternatives as substitutes for it and in this case, the substitutes would be smuggled cigarettes as smuggled cigarettes are cheaper and less opportunity cost would arise in consumption of smuggled cigarettes. Illicit cigarettes are more affordable to everyone, especially teenagers (The Star, 2012). Based on an article in Malaysia Daily, the illicit cigarettes are sold at prices in between RM3.50 to RM5, which is much lower than the price set by the government (Malaysia Daily, 2013). As illicit cigarettes are cheaper and can replace legal cigarettes since it satisfies the same want, thus, as the price of legal cigarettes increases, quantity demanded of legal cigarettes decreases. Being substitutes, the quantity demanded of illicit cigarettes will increase because illicit cigarettes are substitutes of legal cigarettes.
In order to prevent the demand
of illegal cigarettes from increasing, the government should control the
distribution of illegal cigarettes by imposing rules and regulations which
would limit the supply of illegal cigarettes. Governments are advised to
introduce mandatory jail for those who are involved in selling or buying
smuggled cigarettes (Idris, 2012). Their assets and properties should be
confiscated as well so that they do not have a chance to participate in these
illegal activities again because they do not have sufficient assets to do so
(Idris, 2012). Based on the graph above, when the supply of illegal cigarettes
decreases due to the rules and regulations imposed by the government, the
supply curve shifts leftwards. Thus, there is a shortage of illegal cigarettes
at the original price which drives the price up and in turn causes quantity
demanded of illegal cigarettes to fall and quantity supplied of illegal
cigarettes to increase. With a fall in the supply of illegal cigarettes,
ceteris paribus, it will cause a rise in equilibrium price and a fall in
equilibrium quantity of illegal cigarettes. This further discourages the
consumption of illegal cigarettes as the price of illegal cigarettes is now
more expensive with higher opportunity cost involved.
Tax incidence is the division of tax burden between consumers and producers. (Bade and Parkin, 2009). Consumers pay taxes to the extent that price increases and the producers pay to the extent that the rise in price is not enough to cover the tax. When the tax on cigarettes is imposed, this will result in a leftward shift of the supply curve by the amount of tax. Also, since cigarettes are relatively price inelastic, the equilibrium quantity will decrease and hence the tax revenue of the government will be greater. The price will increase by more and hence the consumers’ share of tax is larger whereas the producers’ share is smaller. In this case, the burden of tax is shared between consumers and producers. Based on the article, the World Bank recommended cigarettes tax to be at least 65% but it is only 45% of the retail price of cigarettes in Malaysia (The Star, 2012). Government wants to increase the tax of cigarettes so that it will become unaffordable to youth since the consumers carry most of the tax.
The diagram above shows
the tax burden which is split between consumers and producers. It shows that
the consumers’ share of tax is larger than the producers’ share. It also shows
that the gap between S and S+tax is the amount of tax. The tax results
in the quantity demanded decreasing from Q to Q1.The price of
cigarettes increases from P to P1. However, the producer will receive the price
at P and below because they have to pay part of the tax.
Elasticity of demand is related to this because it determines the division of the burden of a tax. The accurate division depends on the reaction of the consumer to a price raise, which is the price elasticity of demand. Price elasticity of demand measures the responsiveness of quantity demanded of a good to a change in its price only, ceteris paribus. When the demand of a good is price inelastic, an increase in price would result in a less than proportionate fall in its quantity demanded. If a good is price inelastic, in this case cigarettes are considered relatively price inelastic, when taxes are imposed on cigarettes, the quantity demanded of cigarettes will fall less than proportionately, ceteris paribus. This means that the percentage change in the quantity demanded is smaller than the percentage change in the price (Bade and Parkin, 2009). The price elasticity of demand is important to determine the tax and impact on the economy. However, the raise of cigarettes tax will bring both positive and negative impact to the society. Drastic tax hikes will encourages those who cannot afford to buy legal cigarettes to buy cheaper smuggled cigarettes. This is because the price of illegal cigarettes remains at about RM3.50 for the past 10 years (The Star, 2012). The positive impact is increasing of cigarettes tax can boost the economy and gain more government revenue by collecting taxes for our country.
Another factor affecting the
price elasticity of demand of cigarettes in this case is mainly due to the
proportion of income consumers spent on the good. The higher the proportion of income spent on the good, the
higher the price elasticity of demand. For example, the selling price of
cigarettes in Malaysia is so much cheaper the selling price of cigarettes in
Singapore. There are 23.1% of adults and 30.9% of boys aged 13 to 15 have
smoking habit in Malaysia while Singapore has 14.3% of adults and 8% of boys aged 13
to 15 has smoking habit (Idris, 2012). This shows the effectiveness of raising
the price of cigarettes in reducing the number of young smokers. Youth and the
poor who are less financially capable with low income or do not have the
ability to earn money will most likely quit smoking or cut down their
consumption of cigarettes as the money needed to be spent on buying cigarettes
is of higher proportion of their income, hence the consumption of cigarettes
for this group of people will fall more than proportionately since it is more
price elastic.
In
addition, when smokers consume cigarettes, a negative externality is imposed on
people surrounding these smokers who breathe in unhealthy air and suffer from
possible health issues like lung cancer which incur on their medical expenses.
This is a negative externality which results from the consumption of the
cigarettes by the smokers. A negative externality gives rise to external cost
which arises when individual actions inflict costs upon a third party without
the latter being compensated for. These are additional costs borne by people
other than the producer or consumer. In deciding on how much to consume, the
consumer takes into account only the costs he will incur when he consumes the
good, ignoring the external costs that others will suffer. When there are
negative externalities resulting from consumption, the marginal social cost
will be greater than the marginal private cost.
In this case we assume that the private benefit
to the smoker is the only benefit and there are no external benefits. Thus, the
marginal private benefit and marginal social benefit curves are the same at
marginal benefit. The smokers would maximise private benefits by equating its
marginal private benefit and its marginal private cost of consuming cigarettes.
Society on the other hand would maximise their net social benefit when marginal
social benefit equates to marginal social cost. As a result of the output that
maximises the smokers’ benefit at competitive quantity does not equate with the
output that maximises society’s benefit at socially efficient quantity. With
consumers seeking to satisfy their self-interest, the quantity consumed would
be more than the socially optimal level. Society would be better off if
consumption is at socially efficient quantity instead of competitive quantity.
Hence, there is an overconsumption of cigarettes. The overconsumption of
cigarettes leads to a net loss to society. This is the deadweight loss due to
overconsumption.
In a nutshell, government should raise the taxes on cigarettes so that the cigarettes consumption can be reduced.
(1642 words)
References
Bade, R. and Parkin, M. 2009. Foundations of microeconomics. 4th ed. Boston: Pearson/Addison Wesley.
Idris, S. 2012. CIGARETTE PRICES: Higher taxes, fewer smokers - Letters to the Editor - New Straits Times. [online] Available at: http://www.nst.com.my/opinion/letters-to-the-editor/cigarette-prices-higher-taxes-fewer-smokers-1.115730 [Accessed: 5 Jun 2013].
Malaysia Daily. 2013. Sales of illegal cigarettes may be funding crime syndicates - Malaysia Daily. [online] Available at: http://malaysiadaily.my/sales-of-illegal-cigarettes-may-be-funding-crime-syndicates/ [Accessed: 6 Jun 2013].
Sloman, J., Wride, A. and Garratt, D. 2012. Economics. 8th ed. Harlow, England: Pearson.
The Star. 2012. Negative impact of drastic hike. [online] Available at: http://thestar.com.my/news/story.asp?file=/2012/9/14/focus/12024429&sec=focus [Accessed: 6 Jun 2013].
