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The aim of this assignment is to examine the economic impact of taxing sugary drinks. Obesity and its related health problems, is a growing problem in Australia and indeed other parts of the world. Taxes are often  levied on markets where previously no taxes existed to alter consumer and or producer behaviour. The assignment will draw on your understanding of some of the key concepts and models we have studied in chapters 4, 5 & 6 (together with some sections from chapters 1, 7 & 8) of Gans et al. (2015). Ensure your responses to the assignment questions use economic terminology and analysis.

  1. What is the meaning of tax incidence when a tax is levied on a market?
  1. In Chapter 1 of Gans et al. (2015) we studied the 10 economic lessons. Can you identify which economic lesson is applicable to taxing sugary drinks and briefly explain the economics behind this policy.

This question considers the impact of a tax on the market for sugar-sweetened drinks and its impact on related markets. This question does not require you to use actual data for your diagrams, but rather a general representation of these markets. (Use the Insert ® Shapes ® Line feature in MSWord to draw and label your diagrams).

  1. Draw a fully-labelled demand and supply diagram to represent the market for sugar-sweetened drinks.

Illustrate the effect of a tax levied on consumers of sugar-sweetened drinks. Clearly label the changes you have made in your diagram and explain the impact on the equilibrium price and quantity following the introduction of the tax.

  1. Sugar is a key ingredient in the production of sugar-sweetened beverages. Draw a new fullylabelled diagram that represents the Australian sugar market and discuss the likely impact to this market of a tax being levied on sugar-sweetened drinks. Again, clearly label the changes you have made in your diagram and the effect on equilibrium price and quantity of sugar.

iii. The last part of this question looks at the likely impact of a tax on sugar-sweetened drinks on the market for non-sweetened, artificially sweetened or low-sugar beverages.

Draw a fully-labelled diagram that represents these combined markets and discuss the likely impact of the introduction of a sugary drinks tax, explaining the economic relationship between these markets and the sugar-sweetened drinks market.

  1. According to a report by the Grattan Institute (Duckett and Swerissen, 2016), it was estimated that the own price elasticity of demand for sugar-sweetened beverages was -0.9. Briefly interpret this elasticity estimate and discuss its relationship to the effectiveness of a tax on the consumption of sugar-sweetened drinks.
  1. Most studies show that sugary drinks are consumed in high proportions by children and teenagers, as well as low-income households. How would these consumer characteristics help to improve the effectiveness of a consumption tax on sugary drinks?

Impact of Taxing Sugar-Sweetened Drinks on Consumers and Sellers

 Tax incidence 

When a tax is imposed, it has an impact on the distribution of social and social welfare. Tax incidence analyses impact of an imposed tax on economic welfare (Moulin 2014). The group or individual who bears the tax burden directly or indirectly realizes the incidence of taxation.

 The impact of taxation is a part of the microeconomic lesson on demand, supply and elasticity. The lesson contains how the burden of taxes are divided between buyers and sellers based on the respective elasticity. A tax on sugary drinks raises its price. Regardless of whether the tax is imposed on buyers or sellers, it discourages both groups. Sugar is not good for health. Too much intake of sugar leads to several diseases and raises health expenditure of government.  To reduce such costs government often consider taxing sugary drinks (McKenzie and Lee 2016). The tax brings revenue for the government along with improved health condition.

Figure 1: Effect on tax on consumer of sugar-sweetened drinks

(Source: as created by Author)

DD and SS give the pre-tax demand and supply condition in the market for sugar-sweetened drinks respectively. Without tax equilibrium price is set at the level P* and corresponding quantity sold in the market is Q*. E denotes the pre-tax equilibrium point. Now, consider a tax at a rate of ‘t’ is imposed on consumers of sugar-sweetened drinks. As the tax is imposed on buyers, the immediate impact of tax would be on the demand for such drinks (Fine 2016). The contraction in demand is shown by the leftward shift of the demand curve from DD to D1D1. At the new equilibrium, the quantity of sugar-sweetened drinks are reduced from Q to Q1. Because of tax buyers have to pay a high price with price to buyers rises from P* to P1. The sellers on the other hand receives a low equilibrium price of Q1. Now, the government receives a revenue equivalent to the area of the square IP2P1F.

Figure 2: Australian Sugar market

(Source: as created by Author)

Sugar is one of the main ingredients used to prepare sugar-sweetened drinks. Sugar and such sugar-sweetened drinks are complementary goods. In case of complementary goods, an inverse relation exists between price of the one goods and demand of its complementary good. A tax on sugar sweetened drinks raise price that the buyers pay in the market (Dinar 2014). In response to high price consumers of sugar drinks reduces their demand as discussed above. As the sellers, receive a low price their profitability reduces and the market contracts. With contraction in goods market, the input market is affected as well. Each seller of sugar-sweetened drinks now reduces their demand of sugar. As a result, the demand curve of sugar shifted leftward. The contraction in demand given the supply reduces both equilibrium price and quantity in the market.

Impact on the Market for Non-Sweetened, Artificially Sweetened, or Low-Sugar Beverages

Figure 3: Market for non-sweetened, artificially sweetened or low sugar beverages

(Source: as created by Author)

The above figure depicts the impact of taxing sugar-sweetened drinks on the related markets of non-sweetened, artificially sweetened and beverages containing low sugar. These are substitutes of sugar-sweetened drinks. When the price of sugary drinks increases, then consumers substitute consumption of sugary drinks with its substitute products (Bernanke, Antonovics  and Frank 2015). DD and SS indicates the demand and supply in the substitute market. E is the equilibrium. With more people now demanding substitute of sugary drinks the demand will increases. This is shown by the outward shift of the demand curve from DD to D’D’. The increased demand increases both price and quantity in such markets.

Price elasticity of demand explains the proportionate change in quantity demanded in response to a proportionate change in price. The extent of tax burden depends on the measures of elasticity (Arrow 2015). In case of indirect tax, one can pass the burden of taxation on others. The division of tax burden depends on the elasticity of demand and supply. In case of low elasticity of demand, greater burden is born by buyers. If sellers have a less elastic supply, then they are suffered more from taxation. The estimated price elasticity of demand for sugar-sweetened beverages is given as -0.9. That mean 1 percent rise in price leads to a decrease in demand by .9%. That means when price rises then though the buyers cannot reduces their demand by the full extent of tax but can make a considerable contraction in demand.  As buyers are able to reduce their demand significantly, they suffer less from tax imposition. This in turn means although the tax is imposed on buyer, a significant portion of tax burden pass on the sellers. Therefore, the tax on sugar will effectively reduce consumption of sugar or sugar-sweetened drinks.

The incidence of taxation or tax burden depend on elasticity of the particular product. Since the tax is imposed on consumers of sugar-sweetened drinks, the effectiveness of tax depends on the own price elasticity of demand. Sugar drinks are highly consumed by Children, teenagers, and that of low income household. A tax on sugary drinks increases price of these drinks. Mostly children and teenagers prefer to have sugary drinks. Because of little economic understanding, these groups generally have an inelastic demand. With inelastic demand, little increases in price will not affect their demand much. However, both this group have a lower supply of income (Nicholson and Snyder 2014). This makes their demand relatively elastic in nature and hence increases effectiveness of tax on buyers. Low-income household because of low disposable income have relatively elastic demand for sugar-sweetened drinks. A slight increase in the price of such good make them reduce their demand to a considerable extent. For this group demand of sugary drinks with imposition of taxes declines significantly (Mankiw 2016). The tax intends to reduce intake of sugar-sweetened drinks. The low income for teenagers, children and low income household help to achieve a successful implementation of tax on sugar or sugar-sweetened drinks.

References 

Arrow, K., 2015. Microeconomics and operations research: Their interactions and differences. Information Systems Frontiers, 17(1), pp.3-9.

Bernanke, B., Antonovics, K. and Frank, R., 2015. Principles of macroeconomics. McGraw-Hill Higher Education.

Dinar, A., 2014. Foundations and Trends® in Microeconomics. Foundations and Trends® in Microeconomics, 10(2), pp.85-165.

Fine, B., 2016. Microeconomics. University of Chicago Press Economics Books.

Mankiw, N.G., 2016. Economics-Microeconomics-Principles of Microeconomics.

McKenzie, R.B. and Lee, D.R., 2016. Microeconomics for MBAs: The economic way of thinking for managers. Cambridge University Press.

Moulin, H., 2014. Cooperative microeconomics: a game-theoretic introduction. Princeton University Press.

Nicholson, W. and Snyder, C.M., 2014. Intermediate microeconomics and its application. Cengage Learning.

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