The consumption of demerit goods impose negative externalities on the society, where the private costs incurred by the smoker where he/she damages his/her own health, are less than the social costs experienced by the society who involuntarily experience passive smoking, as well as air pollution. However, the price that is paid for each packet of cigarette is not priced with account of the social cost, thus the marginal social cost (MSC) (total cost directly incurred by the producer and any other member of society) will exceed market price and overproduction and overconsumption will occur , causing a misallocation of resources .
In order to account for this marginal social cost, the legislative leaders have considered imposing a tax double the previous amount, to remove this misallocation of resources. This is illustrated through a diagram shown below.
Figure 1 – Tax imposed on negative externality caused by Cigarettes
Marginal Private Benefit (MPB) is relatively inelastic, as smoking has an inelastic demand and MPB = MSB , because there is no benefit involved in smoking. However Marginal Private Cost (MPC) (the marginal cost directly incurred by the producer of the good/service) shifts out as there is an externality that affects the third party, which will be covered through the implementation of a tax. In a free market, people would ignore the external costs to others, therefore the output would be at Q2 where (demand = supply), however this would be socially inefficient as social cost > social benefit. To account for this loss, a tax (S2) is imposed. The amount of tax is P3-P1. The red triangle is the area of dead weight welfare loss. It indicates the area of overconsumption (where MSC is greater than MPC). This shows that a tax would increase the average price of the cigarette. However, the main problem with this is that the value of tax would be quite useless, considering the consumption of cigarettes is an inelastic good. Therefore the tax wouldn’t change the demand significantly. In addition, the other problem associated with taxing cigarettes is how much should the tax be, as how is it possible to measure the level of negative externality. Finally the main problem associated with taxing cigarettes is the involvement of shadow economy, as “they would just have more company on Indian reservations, where they buy untaxed cigarettes at big discounts”, this is instigating people to buy a legal product through illegal methods, as the good is highly addictive, yet they are unable to pay the high price. However, there are still advantages for the government intervention for imposing a bigger tax on cigarettes, as the revenue received will be able to go to health programs, anti-smoking campaigns etc. Furthermore, the main reason for a tax is to achieve social efficiency and if a tax is the method, then so be it.
In reality, the awareness of the dangers of smoking have been around for a long time, so it can be inevitably said that people are making informed decisions for when they choose to smoke. However the social cost of smoking is larger with the problems of passive smoking and environmental concerns. Therefore It is absolutely necessary to try and reduce the number of smoker, for the welfare of others and to protect our planet. But, there are alternative methods the government could use which could reduce the number of smokers or decrease the pollution index, but at the same time not defect any other part of the country’s economy such as crime rate. Other methods could include regulation of minimum age for smoking, the prohibition of smoking in certain areas.
