Cigarettes in Australia have long been subject to excise tax – a per cigarette tax levied on the suppliers of cigarettes. (The tax applies to all tobacco products, however for the purposes of this exam assume cigarette and tobacco consumption are the same thing). In 2016 the federal government announced that the excise tax rate for cigarettes would rise by 12.5% a year for the next 4 years. Over this period tax revenue collected from the sale of cigarettes has increased considerably. Legal cigarette consumption has fallen to an all-time low in Australia due to a combination of the tax on cigarettes, and public health initiatives such as plain packaging, health warnings and banning advertisements.
Part (a) Consider the following two policies aimed at reducing cigarette smoking:
- A tax on the suppliers of cigarettes, and
- The public health campaign initiatives.
Illustrate both of these policies separately using a fully labelled and explained demand and supply diagram for each of parts (i) and (ii). Do not use actual numbers; this is intended as a theoretical exercise.
Compare and contrast the impact on equilibrium price and quantity of cigarettes of each of these policies, explaining your answer with reference to the diagrams.
Consider the impact of each policy on government revenue. Explain your answer.
Can the impact on government revenue be illustrated on either of your diagrams? If so, indicate and explain the area on the diagram/s that represents government revenue.
Part (b) Consider the following quotation:
“When a tax is levied on a good, a share of it is paid by both the consumer and producer. In the case of cigarettes however much more of the burden of the tax is paid by consumers, even though the tax is levied on the suppliers of cigarettes.”
Why might this be the case? In your answer explain both parts (sentences) of this statement.
If the price of a packet of cigarettes increased by 10%, and in light of your explanation of the quotation, would you expect the quantity of cigarettes consumed to increase or decrease, and by more or less than 10%? Explain your answer.
Part (c) Taxation of cigarettes is often justified on the grounds that cigarette smoking creates externalities. What is meant by the term “externalities” in this context? Give two examples of externalities created by cigarette smoking and explain how a tax on cigarettes could potentially address both of these. Using a fully labelled and explained diagram explain how a tax can increase efficiency in the cigarette market.
What size tax should be levied to maximise efficiency in this market? (Indicate the efficient tax size on your diagram – no actual number required).
Part (d) Is a tax on cigarettes a regressive tax or a progressive tax? Explain your answer, including a definition of both terms.
Part (e) Australia’s police forces and border forces have warned that rapid rises in the tax on cigarettes have had unintended consequences of encouraging illegal activity such as smuggling, with proceeds funding other criminal activities. Explain why this might be the case. In your answer refer to the role that elasticity of demand plays in making illegal activity more profitable.
Part (a) Consider a firm called Health-R-Us that is a monopoly. How does Health-RUs decide the price to charge and quantity to sell of the good it has a monopoly on?
Illustrate your answer using a fully labelled and explained market diagram. Assume Health-R-Us is making monopoly profits and illustrate these on the same diagram. In addition, indicate the area on your diagram that illustrates the efficiency cost (the dead weight loss) of the monopoly, and explain why this dead weight loss arises.
Part (b) Assume Health-R-Us is a legal monopoly: it is a monopoly due to legal protection from the government in the form of a patent issued to the company.
Imagine that the government withdraws the legal protection for Health-R-Us such that the market becomes competitive. Will a typical individual firm in this competitive market make economic profit in the long run? Why or why not? Use an appropriate firm-level diagram to illustrate and explain your answer.
Part (c) Your answers to parts 2a and 2b illustrated different levels of profit made by an individual firm in both a monopoly market structure and a competitive market structure respectively. In part 2a you also indicated the dead weight loss of a monopoly.
Assume now that Health-R-Us has discovered a vaccine for coronavirus. Why might the government be willing to grant (and allow to remain in place) a patent to Health- R-Us, despite the dead weight loss and the ensuring monopoly profits caused by such a patent? Explain your answer. For simplicity assume the vaccine is only relevant for the domestic market (i.e., there is no global market for vaccines).