Although price and quantity demanded of a good have an indirect relationship, it is not always completely proportional since different types of goods exist and the sensitivity to price changes varies for each of them. This all depends on price elasticity, which is known as the responsiveness of change in quantity demanded due to a change in price. Alcohol and tobacco are inelastic goods. This means that they are necessity goods, which people either depend on or are addicted to. The quantity demanded of inelastic goods is more likely to respond to price changes less than proportionally, which we can observe on the next page:
Fig. 1: Demand for Alcohol or Cigarettes
We can observe that, as the government increased taxes, the supply curve of that good shifted inwards from S to S1, since taxes rise, costs of production also increase. This shift in supply leads to an increase in price from P to P1, and, the good having inelastic demand, a decrease in quantity demanded less than proportionally from Q to Q1. This allows governments to tax such goods very heavily, and get a lot of revenue from it, but still the quantity demanded does not fall by too much. In the case of cigarettes and alcohol this is a problem, since even though prices rise people still keep consuming it, due to addiction. Therefore, government taxations are not really working for these goods, and they should consider other options such as banning of this products or negative advertising.
Nevertheless, in this particular case, the article states that the major increase in prices “5 % above inflation for tobacco” has lead to a decrease in. The Chancellor George Osborne said that "There is clear evidence that increasing the cost of tobacco encourages smokers to quit and discourages young people from taking it up," and also pub chains complain that they now have less people buying alcohol, since the price has so drastically increased and “the British people are now paying 40% of all the alcohol duties in Europe”.
The problem of alcohol and tobacco consumption leads us to another issue: Market Failure. Governments have to intervene and regulate the market, because in a free market, demerit goods would be over-provided and over-consumed, and since these goods are harmful to society, the over-provision is considered to be a market failure. Cigarettes and alcohol are great examples of this. Smoking and over-consuming alcohol carries with it negative externalities. This means that harm is caused to a third party. In this case, the social benefits to society are less than the private benefits to the consumer, because there is a negative effect suffered by the third parties.
Looking at figure 2 we can observe in the article, where MSC represents the Marginal Social Cost, MSB the Marginal Social Benefit, MPB the Marginal Private Benefit and MPC the Marginal Private Cost:
Market Failure: Negative Externality of Consumption
The government’s objective is to keep the Marginal Social Benefit greater that the Marginal Private Benefit. In this case, they would be able to this by focusing more on aggressive advertising campaigns, highlighting the dangers of excessive cigarette and alcohol consumption. The advertising should raise awareness and therefore reduce demand, which would result in the MPB moving towards the MSB. This would ensure the consumption of cigarettes will reach the Socially Optimal Point, where the Marginal Social Cost equals the Marginal Social Benefit (MSC=MSB). This is a positive effect, since at this point social economic welfare is maximized.
In conclusion, even though it is difficult to fully stop consumption of demerit goods such as alcohol and tobacco, the article shows that a major increase in taxes makes it possible to reduce it. However, as illustrated in the diagrams, no matter by how much the government increases taxes consumption of alcohol and cigarettes will fall less than proportionally, since they are inelastic goods. Also, if they keep rising the taxes an increase in black market activity might occur. Therefore, the government should approach different measures to reduce the consumption of said goods. For example, they could use tax revenue for heavy negative advertising and education to scare people away from consuming these products.
by
csahuquillo55 (student)
