Introtduction
The focus of this blog will be on externalities and how the government interferes to internalize the negative externalities of the production and consumption of the product. As seen in the title the product which will be used are cigarettes. As known, cigarettes have a lot of negative effects and is used by a lot of people. Due to these, negative effects the government must interfere so that the negative externalities will be lessened or even internalized as a whole. The way for the government to do this is adding taxes to cigarettes. When the government intervenes in this way, it can bring about a lot of advantages and disadvantages to the country or state that the increase in the tax of cigarettes is imposed on.
CASE
For this example, we will be using a situation from other parts of the world specifically in America. According to www.rgj.com and www.usatoday.com , on July 1, 2015 marked the first time the Nevada Legislature’s new rule that raised the tax imposed on cigarettes. The amount increased on the tax for cigarettes was raised from $0.80to $1.80, this is the largest tax increase in history as stated in these articles. Gov. Sandoval approved it because the law will help the state create an estimated amount of $192 million; this is because of the increase of tax on cigarettes. The money will then be used to improve the education of the state of Nevada.
CAUSE
Before we go into the advantages and disadvantages of the tax increase, we must first talk about the possible reasons on why the government chose to implement this new law. The cause of the increase in tax is because of the negative externalities of the consumption of cigarettes. First of all, based on the notes copied in class, an externality arises when a person engages in an activity that influences the wellbeing of a bystander who is not part of the original trade-off between the buyer and the supplier. In this case the object being supplied is the cigarettes. The consumption of cigarettes will lead to negative externalities, meaning the bystander will be negatively affected. We are all affected by the consumption of cigarettes when we go near someone who smokes, according to www.webmd.com, the effects of secondhand smoke can cause diseases, heart failure and even cancer. Funny enough, the stand byers or us in this situation is more prone to this than the smokers themselves. According to the same article, in America secondhand smoke from cigarettes lead to 34,000 deaths from heart disease and 7,300 deaths from lung cancer. Recall, market equilibrium is where the supply meets the demand. Not only this but cigarettes can also affect the environment around it due to the pollution from the consumption of the product. In the case of a negative externality, the market equilibrium does not cover the costs or the negative effects of the consumption of cigarettes. The government must intervene and do something about this, and usually the way to “internalize” the externality is to raise the taxes on the product. The graph shown below showcases how the market looks like when there is a product (cigarettes) which brings about negative externalities is consumed too much.
INTERPRETATION
The graph is like this because if there is a negative externality of consumption, the consumer of the cigarettes have more of a benefit which is represented as MSB. This is because the consumer gets what he wants so he benefits, however, the benefit of the society is lower because of the negative effects brought about by the consumption of the cigarettes. An example of these are the secondhand smoking and the negative effects of smoking to the environment. MSB is what is used to represent the benefit of the society from the consumption of cigarettes, as seen in the graph it is lower because of the effects brought about from the consumers. The Qo represents the optimum quantity, because there is an overconsumption of cigarettes and it brings negative externalities, the quantity of cigarettes must be reduced to lessen the effect of the consumption of it. The Po or price optimum becomes less than the price equilibrium because the society will value cigarettes less due to the negative externality brought about by the consumption of it. The Po or price optimum is less than the equilibrium price because the product gives negative effects to society which will lessen the value of the product.
EFFECT
TAX INCIDENCE
Due to the overconsumption of a product which brings about negative externalities, in this case cigarettes, the government must interfere and find a way to internalize these externalities. The usual way for the government to do so is placing taxes on the product. After, we must talk about its effects of this on the suppliers and the consumers. Before going into tax incidence, we must learn about the elasticity of cigarettes. According to Rod Friesen, who is the manager of the Tinder Box which is a tobacco shop that has been in the business for 87 years stated that people do quit when there is an increase in the tax for cigarettes. He also stated this: “I see it every time they raise taxes. There are people who quit, or switch to a different form, like e-cigarettes.”. According to the Campaign for Tobacco-Free Kids, there is a negative relationship between the amount of the price of the product to the amount of consumers. When there is an increase of 20% in tax, then this reduces the amount of smokers who are young by 14%. This shows that cigarettes are indeed elastic because it can be easily be substituted by other goods such as e-cigarettes. The increase in price can also make consumers quit the usage of cigarettes and instead start finding other means to replace the use of cigarettes.
GRAPH
During class we discussed how the increase in tax is a way for the government to intervene in the overconsumption of a product which brings about negative externalities. We also learned that when a tax is placed upon an elastic product, the suppliers or the producers will carry more of the burden of the tax. This happens because there will be less consumers after tax, this will lead to the producers carrying more of the burden of the tax. A graph which shows this will look like this below.
INTERPRETATION
The graph shows that the producers pay more when the demand for a product is elastic. As discussed earlier, cigarettes are elastic because of the availability of close substitutes like e-cigarettes and other vices. The elastic demand is shown by the flat line. Supply 0 shows the supply before the tax was implemented, while Supply 1 shows the supply after the higher taxes was implemented. The green part showcases the burden of the producers, while the orange shaded part shows the burden of the tax on the consumers.
CONCLUSION AND SUMMARY
In this blog post, we learned about what an externality is and the negative externalities of cigarettes. We also learned how to create a graph of this product showing the optimum quantity, optimum price, marginal private and social benefits, as well as the marginal private and social costs compared to the market equilibrium. We showed how a government can intervene to internalize the negative externalities brought about the consumption of cigarettes by increasing the tax on the product. After that, we finally talked about the increase in tax’s effect on the market for cigarettes and how the burden of the tax falls on the producers. Through this we can see that the government has a big role to play in making the market fair for everyone, the government must be able to the optimum price and quantity of a certain good based on its externalities.
SOURCES
SOURCES:
- http://www.prnewswire.com/news-releases/nevada-tobacco-tax-increase-is-big-win-for-kids-and-health-300091795.html
- http://www.rgj.com/story/news/politics/2015/07/03/states-largest-ever-cigarette-tax-hike-burns-smokers/29685251/
- http://www.rgj.com/story/news/politics/2015/07/03/states-largest-ever-cigarette-tax-hike-burns-smokers/29685251/
- http://www.usatoday.com/story/news/2015/06/01/nevada-tax-hike-sandoval-education/28309841/
- https://sophiaheconomics.wordpress.com/2013/02/06/negative-externalities-of-smoking/
- http://www.webmd.com/smoking-cessation/effects-of-secondhand-smoke/