Taxes and Elasticity of Cigarette Demand Essay

Taxes and Elasticity of Cigarette DemandWhile smoking is linked to serious health consequences felt by the greater community, the addictive qualities of tobacco in cigarettes make it difficult for individuals to abstain from smoking.

  Governments, recognizing the long term costs of cigarette use on the health care system and its citizens, have limited options to curb this activity as the choice to smoke is personal and a protected freedom.  One lever of opportunity to reduce demand for cigarettes while maintaining individual’s right to choose is through taxation.  Following the economic principle that demand for goods decreases as price increases, it could be speculated that increased pricing through taxation could generate lower cigarette consumption.  At the same time, the addictive nature of cigarettes make the product uniquely categorized among what are considered “normal” goods.  As such, to project the effect of higher taxes on cigarettes aimed at raising their prices, the short and long run elasticity of price demand for cigarettes must be established.

  Elasticity of price demand, “the proportionate change in demand given a price change”(Anderson,  McLellan, Overton, & Wolfram, 1997), is the most effective metric to estimate the result generated by the taxation lever.  With this information, the effect of price increases on tobacco and other products with addictive and arguably self destructive qualities, the impact of price increases on consumers of different age groups, and the long run change in demand for cigarette smoking can be estimated.Effects of Price Increases on Young Adults and All AdultsRecognizing that young adults have unique personal and economic characteristics that evolve over time during their maturation process, price increases on cigarettes will impact them differently from their older counterparts.  Young people typically have lower levels of disposable income.  This has a dramatic effect on their price elasticity of demand for all products, “Economic theory implies that the price sensitivity of demand rises with the share of income spent on a good” (Chaloupka, 1998, p. 2).  With less disposable income, young adults are more sensitive to price increases.  Further, young people are more easily influenced by the actions of their peers in making personal choices.

  Peer pressure “occurs when the individual experiences implicit or explicit persuasion, sometimes amounting to coercion, to adopt similar values, beliefs, and goals, or to participate in the same activities as those in the peer group” (Bourne, 2001).  While typically viewed as negative, peer pressure can have positive effects on the behavior of young adults as well.  In this case, an individual choice by a young adult to cease or reduce cigarette consumption can have a greater impact in modifying the behavior of their counterparts through peer pressure than would a similar choice made by an adult.  A multiplier effect reducing group demand from individual behavior is created among among young people not enjoyed by older smokers.  Additionally, young cigarette consumers, having smoked for fewer years are less sensitive to both the addictive qualities of the nicotine and the force of habit.

   The adage “old habits die hard” plays in their favor.  Not surprisingly, given these unique characteristics for young adults, empirical research on the price elasticity of demand for cigarettes among youth smokers supports the hypotheis that they are more sensitive to price increases than consumers outside their age group.Empirical Evidence of Price Elasticity of Demand for CigarettesStudies conducted by Lewit, Coate and Grossman (1981) sampling over 5,300 youth smokers indicated than among 12-17 year olds price elasticity of demand was -1.44 (Lewis, Coate and Grossman 1982, as cited in Chaloupka, 1998) .   A 10% increase in cigarette pricing would yield a drop in demand among young people of over 14%.  Adult smokers are less sensitive to price increases in their demand for cigarettes.

  Though an inverse relationship between cigarette price and demand exists among individuals aged 20 to 70, Lewis and Coate (1982) determined the elasticity of demand for cigarettes in this groups at -0.42 in sampling of over 19,000 participants in the study (Lewis and Coate, as cited in Chaloupka, 1998).  These findings are consistent with further data resulting from research on this topic, “Chaloupka and Grossman confirmed the findings from earlier studies that youth are about three times more sensitive to price than adult smokers are” (Chaloupka, p. 4).  These results indicate that the unique social and economic characteristics of young adults are reflected in their greater price elasticity of demand for cigarettes.Substitutes for Tobacco UseJust as an increase in the price of coal can lead to a shift in the demand schedule for natural gas, a substitute commodity when it comes to the heating of homes, increasing cigarette pricing could lead consumers to shift their consumption to other forms of tobacco including chewing tobacco and snuff.

  As products in the tobacco group all contain nicotine, which is the addictive ingredient in tobacco which stimulates demand for these products, substitute tobacco products should be taxed at a higher rate as well if the aim is to curb aggregate tobacco consumption.  By taxing all tobacco products, governments can have the greatest impact on reducing cancer related to tobacco use.Long Run Elasticity of Demand for Cigarette SmokingResearch indicates that the long run price elasticity of demand for cigarettes is double that of the short run (Chaloupka, 1998).

  While short run price elasticity of demand established by the National Cancer Institute (1993) was estimated at a range of -0.3 to -0.5, long run price elasticity of demand approaches -0.8 (Chaloupka).  In the short run, the increase in revenue from increased cigarette taxes are only marginally offset by reduction in consumption, the government will see larger aggregate revenues from tobacco through the tax increases.  In the long run, as the price elasticity of demand for this product doubles, revenue increases will be smaller than in the immediate period beyond the price increase.  This loss of revenue will be more than offset however, by the increase in associated health benefits and reduction in cancer rates.  The effect of long run behavior of price elasticity of demand for cigarettes implies that taxes have a measurable impact on consumer behavior.

  Taxes in this case are an effective lever for government in their efforts to modify consumer choices away from tobacco.  Further, it implies that in the long run the government will continue to implement additional tax increases on cigarettes to prevent the impact of the tax increase to be dilluted through inflation.  Unless cigarette prices rise at a rate at least proportional and ideally higher than the rate of inflation they will lose their desired impact in curbing tobacco use.Effects of Taxation on Alchohol and Similar ProductsWhile not a direct substitute for cigarettes, alchohol is often a complementary good to cigarettes, both are stimulants and often consumed together.  Further strengthening this definition of cigarettes as a complementary good to alchohol is a study completed in Taiwan, where they established evidence of what they describe in medical terms as a “synergistic relationship” between cigarette and alcohol consumption:  “We find that the NT$10 health tax on cigarettes will reduce cigarette consumption by a significant 27.

22%” (Lee, 2007).  A similar result was evidenced in the consumption of betel nuts; also a stimulant with poor health effects, as cigarette taxes were increased, demand for cigarettes and the complementary good of betel nuts fell in accordance with economic theory which would predict a shift in demand for a complementary good when the price of its complement rises.  Since empirical research has established that negative price elasticity exists for an addictive good with long run damaging health effects, cigarettes, and indicates an appropriate shift in demand for complementary stimulant goods with similar addiction and health concerns, the inference that taxes can be used to curb demand for alcohol is reasonable.ConclusionCigarette price increases through taxation are an effective lever that governments can used to modify consumption behavior which will, in the long run, yield significant savings to health care costs shared by the community as a result of individuals choosing to smoke as long as subsitute goods in the tobacco family see similar price increases at or above the inflation rate.  Empirical research indicates a negative price elasticity of demand for cigarettes that is stronger in youths than adults due to social and economic characteristics unique to young people, specifically disposable income, peer pressure and addiction level.  Further, the effect of cigarette price increases is evidenced by downward shifts in demand for complementary stimulants with long term health consequences like alcohol.  Taxation is an effective policy to curb self destructive consumption habits.

ReferencesAnderson, P. L.,  McLellan, R. D., Overton, J. P., & Wolfram, G. L.

(1997). Price Elasticity of Demand. Retrieved November 21, 2008, from http://www.mackinac.org/article.asp?ID=1247Bourne, H. (2001). Peer Pressure.

Retrieved November 21, 2008, from http://findarticles.com/p/articles/mi_g2699/is_0005/ai_2699000579Chaloupka, F. J. (1998). The impact of Proposed Cigarette Price Increases. Retrieved November 21, 2008, from http://tigger.uic.

edu/~fjc/Presentations/Papers/hsap_policy9.pdfLee, J. (2007). The synergistic effect of cigarette taxes on the consumption of cigarettes, alcohol and betel nuts. Retrieved November 21, 2008, from http://www.pubmedcentral.nih.gov/articlerender.fcgi?artid=1913507