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demand and supply of cigarettes

Cigarette Smoking and Taxes (adapted from lesson in economics.about.com)
Cigarette taxes are a hot topic in Economics for many reasons. Cigarettes are considered goods with a negative externality. This implies that some external parties are negatively affected by the private transaction of others. For instance, cigarettes produce second hand smoke such that even nonsmokers are adversely affected by cigarette consumption. In addition, there are large health care costs of cigarette smoking. Therefore, public policymakers often want to reduce cigarette consumption. There are two ways that they can achieve this goal:
One way to reduce smoking is to reduce demand for the good. This will shift the demand curve to the left, and the quantity of cigarettes consumed will be reduced. The second way to reduce smoking is to raise the price of cigarettes, which will decrease the quantity demanded of cigarettes.
1. What are some ways public policymakers can reduce demand of cigarettes (shift of the demand curve)?
2. Suppose the government decides to implement a tax on cigarette manufacturers in order to raise the price of cigarettes. How much does the amount of smoking respond to changes in the price of cigarettes? Be sure to explain your answer using the concept of elasticity.
3. Who pays the larger burden of the tax (buyer or seller)? Why? Be sure to explain your answer using the concept of elasticity.

Solution Preview

There are various ways in which policy makers can influence demand and supply of cigarettes. Let us start with demand. The factors that influence the demand of any good or service are the following:

1. Price of related goods
2. Expected future prices
3. Income
4. Expected future income
5. Demography
6. Preferences

Out of these there is not much that we they can do about the first: cigarette does not have any readily available substitute. The same can be said about income. Though people tend to consume more cigarettes as their income rises, once again no policy maker wants to lower income or expected future income. Demography is again something that one cannot do anything about. That leaves us with two factors: expected future prices and preferences. The government and policy makers can influence these, but an increase in future prices will increase demand today: something that the policy makers will not want. The only demand side effect left over now is people's preference. Policy makers can take initiatives to increase ...

Solution Summary

The demand and supply of cigarettes is discussed thoroughly.

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