Effects Of Excise Tax On Tobacco Products And Market Analysis

Impact of Excise Tax on Sellers and Buyers

As of March 1, 2018 the effective exercise tax of 0.71046 per sticks of cigarette (ato.gov.au, 2018).

Total tax paid on standard packet of 20 cigarette is (20*$0.71046) = $14.2092.

The before tax price is ($30 – $14.2092) = $15.79.

Excessive consumption of tobacco items causes severe health hazards adding to an increases in health expenditure. In order to reduce the consumption to tobacco products Australian government imposes exercise tax on tobacco products to a considerably high level. Exercise tax is a kind of indirect tax. In contrast to direct taxes, the incidence of taxes here can be shifted from sellers to buyers. The burden of tax thus shared between both the groups. In the tax incidence, an important role is played by the concept of elasticity. Price elasticity of demand is an indicator of responsiveness of demand with respect to price. The most important determinant of demand is price. Increase in price causes a reduction in demand. However, extent of the demand change depends on the concerned price elasticity of demand. Price elasticity of demand stands to capture magnitude of change in demand as a result of change in prices. Based on the relative change in demand with respect to a change in price elasticity is classified in several categories (Maurice & Thomas, 2015). Commodities for which change in demand is relatively higher than the change in price is said to have a relatively elastic demand. In this case, a small change in price causes a much greater change in demand. The estimated price elasticity of demand for these types of commodity is greater than 1. In case of relatively elastic demand, the proportionate change in demand is less than the proportionate change in price. This yields a price elasticity measure less than one. Several factor influences the elasticity the demand. Nature of commodity is one important factor affecting demand elasticity. Addictive items like tobacco tends to have a relatively inelastic demand. For these products, people are unwilling to alter their demand in response to price (tobaccoinaustralia.org.au, 2018). Now, for such product even after imposition of tax people do not reduce their demand much. As people continue to purchase such products at a high price most of tax burden is borne by the buyers as compared to the sellers group. The impact of tax on tobacco products is discussed below using the standard demand supply framework.

The upward rising curve SS shows the supply curve for tobacco products. The downward sloping steep curve represents the demand curve. Without tax, the free market equilibrium exits at e. P* and Q* are the free market equilibrium price and quantity respectively. Consider now the effect of imposition of an exercise tax of ‘t’ on seller. The first direct impact of the tax is on the seller. Because of reduced profit margin sellers now supply a relatively less quantity of the goods. According the supply curve shifts to the left. e₁ is the new equilibrium point associated with a high price P₁ and a smaller equilibrium quantity Q₂. The equilibrium price denotes the tax inclusive price (Hoag, 2013). This price is paid by the buyers. Sellers on the other hand receives are a relatively small price of P_2. The revenue earned by the government is shown as P₁e₁gP₂. As shown from the diagram, (P₁ – P*) > (P* – P₂). The tax burden to the buyer is P₁e₁fP*. The tax burden to seller is shown as the area P*fgP₂. Following the relatively inelastic nature of the demand buyers bear a greater tax burden.

Q	TC	TFC	TVC	ATC	AFC	AVC	MC
0	50	50	0
1	100	50	50	100.00	50.00	50.00	50
2	140	50	90	70.00	25.00	45.00	40
3	170	50	120	56.67	16.67	40.00	30
4	190	50	140	47.50	12.50	35.00	20
5	210	50	160	42.00	10.00	32.00	20
6	230	50	180	38.33	8.33	30.00	20
7	260	50	210	37.14	7.14	30.00	30
8	300	50	250	37.50	6.25	31.25	40
9	350	50	300	38.89	5.56	33.33	50
10	410	50	360	41.00	5.00	36.00	60

Table of Costs and Output Determination

In a perfectly competitive market, the short run equilibrium condition is given as price equals marginal cost of production (Melvin & Boyes, 2013). The price in the competitive market is given as $35. There is no unit of output where the associated marginal cost is $35. For 7 unit of output marginal cost is $30 and for 8 units of output marginal cost is $40. As marginal cost lies between this range, optimal output is between 7 and 8.  Firm in the perfectly competitive market choses to produce 7.5 units of output in the short run.

As obtained above the price in the short run is less than the average total cost implying firms in this market incur a short run loss. The price however is higher than average variable cost implying the firm is operating at the break-even point (Perloff, 2015). In the short run the firm might continue its operation as long as price is greater than minimum average variable cost. If the long run price is continued to $35, then price still remains below the average total cost. The loss making firms in the long run exists the industry.

In economies, market in economics is defined as an arrangement where buyers and sellers come in close contact either directly or indirectly sell and buy commodities. Based on number of sellers and buyers present in the markets are of four types (REA, 2013). These are perfectly competitive market, monopoly, oligopoly and monopolistic competition.

The monopolistically competitive market is a market model where large number of seller provide a differentiated product in the market. In this form of market, each seller has multiple competitor but each one of them sells a slightly different products. Each firms takes is own decision like a monopolist. Extensive competition exists among different firms in the industry (Arthur, 2018). Products in the markets can be differentiated in any of four ways – marketing differentiation, differentiation in human capital, physical product differentiation and differentiation through distribution. Some common examples of monopolistically competitive market include coffee shops, hotel or restaurant business, automotive service companies, grocery stores and others.

Another form of imperfectly competitive market is oligopoly market. In thus form of market few large sellers operate in the market occupying a significantly large share in the market (Becker, 2017). In Australia, the grocery supermarket has few dominating sellers namely Woolworths, Coles, Aldi, Tesco and Morrison.

Though both oligopoly and monopolistic competition are examples of imperfectly competitive markets, the two types of markets differ in a number of aspects

Monopolistic Competition vs. Oligopoly

Number of sellers

In a monopolistically competitive market, there is a large number of small firms. In an oligopoly market in contrast, there are small number of large numbers.

Market share

Each firms in a monopolistically competitive market has a relatively small share in the market. Hence, no firms have much market power and cannot influence prices in the market. The concentration among firms is high in the oligopoly market giving firms a considerable market power (Belleflamme & Peitz, 2015).

Entry and exist

Like perfect competition, firms in the monopolistic competition can easily enter or exit the market. While in the oligopoly market firms face a high barrier to entry.

Long run profit

The long run profit is different in the two markets. The monopolistically competitive firms in the long run can earn only a normal profit. In the short run firms however there can be either economic profit or loss. In presence of economic profits, new firms enter the industry. supply increases leading to a decreases in price and profitability. With economic loss, some firms exit the industry (Waldman & Jensen, 2016). This reduces supply in the industry, pull up price and normal profit is restored. Oligopolistic firms on the other hand can maintain a supernormal profit even in the long run with restricting entry on new firms in the industry.

Geographic boundary

Another key factor of differentiating market structure is location of the market. Markets in a small city may have an oligopoly market structure while in a large city presence of large number of firms make the market structure monopolistically competitive (Hoag, 2013). In s large city for examples there are various shopping centers, supermarkets and different nationwide chain. These markets generally represent monopolistic competition. A small city on the other hand has less number of such outlets and have a few stores only. This makes the market structure an oligopoly.

In Australia, different state governments have initiated amalgamation with the belief that a larger local government body is able to provide services in an efficient and effective way. A sound governmental body brings an increased level of welfare for the citizen. During 1990s, the primary arguments for amalgamation was the predicted cost reduction from consolidation. In Victoria, a 20% cost saving was suggested from mergers between different levels of government (Aulich, Sansom & McKinlay, 2014). In rural region of Western Australia also mergers lead to a considerable reduction in costs and contributes to a greater sustainability of community.

Economic Rationale for Merging Local Government Councils

Economies of scale

 Realization of economies of scale is often presented one of the primary arguments for mergers between state and local government. A firm is said to enjoy benefits of economies of scale when there is a fall in average cost of production with every unit increase in output. In determining optimal size of the government economies of scale plays an important role. For public goods and services, economies of scale lead to a reduction in per head cost of providing such services with increase in mass of population (Dollery & Drew, 2017). A larger unit of jurisdiction means is associated with a smaller per capita cost. The benefits of economies of scale is particularly relevant for goods and services that have a high fixed cost in relation to the variable cost of production.

Cost of administration and compliance

Any government body include huge amount of administration cost and cost of compliances for participants of the political process. A consolidated government body helps to economize both administration and compliance cost. The administrative cost involves cost of salaries to employed government officials, maintenance of building, utilities and other necessary expenses (Dollery, Kortt & Drew, 2016). The compliance costs are the cost for keeping voters informed on issues and position of candidates, cost of arranging meetings, voting, hearing and others. A centralized planning system leads to a reduction in administrative costs.

Economies of scope

The economies of scope are associated with economies of joint production. Firms by producing a range of goods enjoy a cost advantage over production of single good. In context of mergers between government bodies, economies of scope exist when offering a particular public service is less costly from a single organization than offering the same from different government organization (Stiglitz & Rosengard, 2015). When governments merged, then there is a decline in overhead cost of fixed inputs like cost of administrative staffs. The combined cost of such fixed inputs is less than that for separate levels of government.

Strategic capacity

Recently a greater emphasis is placed on improvement of viability and capacity of a larger government body rather than its implication for direct cost savings. Argument has been placed in favor of increasing opportunities for economies of scope generatesd from a larger body of government and improve strategic capacity for local government. The enhanced capacity of government body enables to undertake new or improved services that was not possible by the single government body (Hosken, Miller & Weinberg, 2017). The consolidated body of government can then shift their attention to a more strategic operation with a greater efficiency.

References 

Price elasticity of demand for tobacco products – Tobacco In Australia. (2018). Tobaccoinaustralia.org.au. Retrieved 19 April 2018, from https://www.tobaccoinaustralia.org.au/chapter-13-taxation/13-1-price-elasticity-of-demand-for-tobacco-produc

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REA, T. (2013). Microeconomics Essentials. Newburyport: Research & Education Association.

Arthur, W. B. (2018). Self-reinforcing mechanisms in economics. In The economy as an evolving complex system(pp. 9-31). CRC Press.

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Aulich, C., Sansom, G., & McKinlay, P. (2014). A fresh look at municipal consolidation in Australia. Local Government Studies, 40(1), 1-20.

Dollery, B., & Drew, J. (2017). Hired guns: Local government mergers in New South Wales and the KPMG modelling report. Australian Accounting Review, 27(3), 263-272.

Dollery, B., Kortt, M., & Drew, J. (2016). Australian local government perspectives on contemporary structural reform(pp. 179-204). Hershey PA: IGI Global.

Stiglitz, J. E., & Rosengard, J. K. (2015). Economics of the Public Sector: Fourth International Student Edition. WW Norton & Company.

Hosken, D., Miller, N., & Weinberg, M. (2017). Ex Post Merger Evaluation: How Does it Help Ex Ante?. Journal of European Competition Law & Practice, 8(1), 41-46.

Excise rates for tobacco. (2018). Ato.gov.au. Retrieved 19 April 2018, from https://www.ato.gov.au/Business/Excise-and-excise-equivalent-goods/Tobacco-excise/Excise-rates-for-tobacco/