Factors Affecting The Demand And Supply Of Cigarettes In The Australian Market Essay.

The Market of Cigarettes in Australia

Question:

Discuss about the Investigation into Supply and Demand of Cigarettes.

This paper will help us to understand the demand and supply of cigarettes in Australia. We shall also mention the factors affecting the market in terms of the supply of and the demand for cigarettes in the tobacco industry, including the income effect, effects of close substitutes and complements, as well as the price and income elasticity of cigarettes in the market.

A cigarette is a product derived from cured tobacco and finely processed tobacco leaves, and reconstituted tobacco, rolled or stuffed into a paper cylinder. It is consumed through smoking, either on its own or with other combined additives. The market of cigarettes in Australia falls under the tobacco industry.

The tobacco market in Australia is part of the world tobacco industry. There are three important tobacco companies with operations in Australia. These are Phillip Morris International (Australia), Imperial Tobacco Australia, and British American Tobacco Australia which are wholly owned subsidiaries if the parent companies abroad. Despite the restrictive regulatory environment that encompasses these companies, they continue to thrive successfully in operations and are highly profitable. This is in spite of the Australian tobacco market being considered mature with reducing consumption per capita.

Information about the operations of the local companies is very limited. This is because the companies are owned overseas and they are not listed in the Australian Securities Exchange. Only British American Tobacco Australia and Philip Morris offer little information on their websites. In the case of Imperial Tobacco Australia, there is very limited information on the operations in Australia. The big part of information that is used in this paper about the market for cigarettes and the Australian tobacco companies and their environments of operation, have been sourced from reports and other literature that were published by other authors.

For every business enterprise, the determination of the price of its products is very important not only for the success of the product but also for the profitability of the organisation. The organisation must consider the effective demand and the effective supply of its products and come up with the best price that will maximise revenue generation for the organisation. Changes in price of the products will affect its demand and in turn affect the operations of the organisation. These fluctuations in prices will be as a result of the internal or external environment, or both of the conditions in which the organisation operates.

Demand for a product or service is how much of the commodity a buyer will want to purchase at a particular price in the market. It is the amount of a particular commodity that a consumer or a group of consumers are willing and able to buy, given a particular price over a specific time. When the quantity demanded and the price are plotted on a graph, it gives the demand curve. The prices and the quantity demanded of a good or service have an inverse relationship. This implies that, the quantity demanded reduces whenever prices increase, and vice versa (Salvatore, 2011). This relationship between the price and the quantity demanded can be expressed in the form of a demand curve as shown in the figure below. The line DD is the demand curve of the commodity

Tobacco Industry in Australia

Demand for a commodity is usually determined by the price of the commodity in addition to the prices of other related commodities. The relationship between commodities may be in the form of substitutes where the products can be used as an alternative for each other, or can complement each other in that they go together in consumption. However, there are cases where the own price of the commodity does not affect the demand for it. An example of such commodities is cigarettes where demand is not related to price completely and in extreme cases, it is infinite at any given price (Beardshaw, 2001).

Philp, Dan and Galt (2009) observed that the demand in relation to cigarette smoking as caused by a number of determinants with the major factor being the current own price of the cigarettes. Due to this, the quantity demanded of cigarettes is a function of its price, the income level of the individual consumer, existence of other related goods like substitutes (herbal and electronic cigarettes, shisha, etc.), and other external factors like raw material and labour availability, which affect the final price of the good. we can then represent this information mathematically as Q^d = f (P, Y, R, E), where Q^d is the quantity of cigarettes demanded, P is the price of cigarettes, R is the price of the related good in this case its substitutes, and E represents the external factors that affect the final price of the cigarettes.

When we consider this equation, it will be difficult to deduce the influential demand of cigarettes due to the diversity of the independent variables that will constitute the quantity demanded and the market price. Hence, we will assume that all the other factors are held constant and then we will analyse the quantity demanded as a function of its price alone. In the figure above, we can note that the higher the price of cigarettes, the lesser the quantity of it is demanded. Consequently, prices will have to reduce for demand of cigarettes to increase. This is the law of demand. The price elasticity of demand is the measure of how much the quantity demanded will respond to the changes in the price of the commodity.

Previous studies have found that the quantity consumed of cigarettes is not related to price. This means that changes in the price of cigarettes has little or insignificant effect on the quantity consumed. It is because of this that many economists view the consumption of cigarettes as illogical in the sense that it does not obey the fundamental law of demand in economics. The same applies to consumer’s disposable income where changes are inconsistent with demand. In this case, income may have a negative effect or no effect at all to the consumer’s demand.

The Australian government has put a lot of effort in reducing cigarette smoking among its citizens. In a bid to reduce smoking in public places and private places of duty because of the harm to other non-smokers and to the environment. Government policies have been put into place, including taxation and retraction in advertising and promotion. These measures have had an impact in the demand for cigarettes, which has reduced considerably especially to the younger generation.

Price Determination of Products

Supply refers to how much a seller is able and also willing to avail goods or services to the market at a given price. It is the quantity of a particular commodity that a seller wishes to sell at every possible price in the given market at a particular time, holding other factors constant. Supply is related to scarcity in that only scarce commodities have a price attached to them.  The relationship between the price and quantity supplied of the commodity, when plotted on a graph will yield the supply curve. Whenever the price of a commodity is high, suppliers will be willing to bring more of the commodity to the market. the reverse happens when the prices are low- less of the commodity will be supplied. The relationship between prices and the quantity supplied is direct. This is shown in the figure below. The line SS is the supply curve.

According to Philp, Dan and Galt (2009), supply in the cigarette market shows the number of competitors setting the price of cigarettes. The quantity supplied is a function of the level of technology which will determine the price, the expenses incurred to acquire resources needed to produce cigarettes, presence of substitutes, the manufacturing process and other external factors such the cost of capital and labour. All these are the factors that affect the supply of cigarettes. We will represent this mathematically as Q^s = t (P, F^r, F^m, w), where Q^s is the quantity supplied, T is the level of technology used in production, P is the price of cigarettes, F^r is the cost of resources such as labour, F^m is the quality of the manufacturing process, and w represent the other charges like cost of machinery. Identical to the analysis of demand, we will hold the other factors constant and relate quantity to price as its function.

From the supply curve above, we can see that investments in production will require a certain level of supply to reach the break-even point. Because of this, the higher the capital spent on the price, the more the organisation will need to supply. It is due to this that cigarette-manufacturing companies differentiate their products and push for a higher supply so as to maximise profit. Whenever the prices are high then there will be high supply of the commodity to the market and vice versa. This is the law of supply.

Conclusion

We have seen how the forces of demand and supply work in the market for cigarettes and how this information can assist management in making decisions concerning demand and supply. It is important to note that the supply and demand of cigarettes is not affected by its own price but other factors such substitutes and government policy.

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