Normally, industries will produce at a quantity (Q*) and sell at a price (P*), where the demand curve cuts the supply curve. However, as the world’s population increases rapidly and enhances the income growth in developed countries, people can now easily afford luxury goods such as tobacco. Due to these factors, the demand curve is shifted from D to D’ while the supply curve doesn’t shift. Hence, the equilibrium price is increased to P’ and the quantity demand will also increase to Q’. This is probably the reason why tobacco consumption is expected to increase in 2010. In addition, the change in supply will affect both the price and quantity too. In the article, it is said that
“ Supply is expected to increase in countries where production costs are low, there are no production restrictions, and good transportation systems and access to international markets are available.”
The factors mentioned above will shift the supply curve. As the production cost is reduced, the supply curve will shift outwards, with supply at a quantity Q” sold at a price P”. To reduce the consumption of tobacco per adult, the Food and Agriculture Organization suggested “using a combination of tax and direct restriction policies.” Referring to Fig.2, the imposition of tax has increased the production cost, which shifts the supply curve inwards. As the producers have to sell at a price lower than they used to, they would produce less cigarettes or simply close down the business for lack of profit. Eventually the consumers have to pay more than they used to and they would buy less. In conclusion, the imposition of tax is an extremely effective way to reduce the consumption of tobacco.
As mentioned in the second paragraph, tax benefits the government but not the consumers and producers. Fig. 2 shows how the money is taken from the consumers and producers by the government. As the shift of the supply curve occurs, the maximum price (Pc in Fig. 2) the consumers are willing to pay has increased and the minimum price (Pp in Fig. 2) the producers are willing to sell has lowered. Therefore, the blue area shows the loss in consumer surplus; the red area is the loss in producer surplus, which contributes to the government tax revenue (the green area). However, the yellow triangular area is the deadweight loss of society. Neither the government nor the consumers and the producers receive it. From this, we can see that the imposition of tax not only reduces the quantity of the goods in the market, but also helps the government to gain revenue from the consumers and producers.
In the article, the author seems to have forgotten to mention that the tobacco market has negative externalities. Tobacco is a demerit good, there is an external cost in consumption endured by the 3rd party that is not part of transaction. Fig. 3 shows how the external cost (EC) affects the market. Reference can be made to the following principles:
MSB(marginal social benefit) = MPB(marginal private benefit) + EB(external benefit)
MSC(marginal social cost) = MPC(marginal private cost) + EC(external cost)
In Fig. 3, S=MPC=MSC since there is no external cost in production. But external cost exists in consumption, which is negative external benefit to the MPB, resulting in MSB to be below MPB. From this, we can see that the private optimal quantity is larger than the social optimal quantity. This is over consumption. To remedy this market failure, the government can impose an indirect tax to shift the MPC inwards, making Q and Q* the same. This is identical to Fig. 2, where Pc increases and Pp decreases such that the government gains the tax revenue. Finally, there are other solutions rather than legal restriction and tax, such as education, prohibition and promotion. These methods can also reduce the consumption of tobacco.
