Analyzing Demand Response Using Linear Function Bidding

Impact of Tobacco Taxation on Demand and Supply

Discuss About The Demand Response Using Linear Function Bidding.

Considering the government’s announcement back in 2016 regarding the tax rate increase on the cigarette and data from the Australian taxation law office, it can be stated that prevailing tax rate as on 1^st of January 2018 on the standard 20 packet of cigarettes is 12.5% (Excise rates for tobacco, 2018).

If the price of a standard 20 packet cigarette is considered to be $30 post taxation, then the pre-tax price would be 26.67$.

Now, as the tax on the cigarette has been imposed it was aimed to reduce the consumption of the same at a large scale, however, whether it achieved its desired target or not, that need to be checked out. In order to do the same, it would be beneficial to describe the tobacco taxation effect though utilising the supply and demand framework.

Figure 1: Demand and supply framework of tobacco market

Source: (Created by Author)

From the figure 1, the demand and supply framework of the tobacco market can be seen and in spite of the fact that demand and supply model is a simple economic framework, it can easily determine the price and quantity demanded of the product (Ruttan & Thirtle 2014). Not only can this, in addition to it, supply and demand model explain the factors that cause change in the price and the demand of the same. Moving forward, from figure 1, it can be seen that the demand is represented by the D1 and the initial supply is represented through the S1. Quantity demanded has been represented in the horizontal axis and the price of the tobacco product has been showcased in the vertical axis (Li, Chen & Dahleh, 2015). Now at the initial equilibrium price is P1 and the demand is Q1 as, at this point the supply of the tobacco equates with the demand of the same.

Considering the fact that, government has imposed excise duty, then it is ought to reduce the supply of the tobacco products and from the figure 1, this phenomenon can be represented through the upward shift of the supply curve (Canto, Joines & Laffer 2014). Post taxation, supply curve has moved upward to a new position S2 and at the place where it cuts the demand curve, equilibrium will be determined there. At the new equilibrium, price is P2 and the quantity demanded is Q2 (Zoutman, Gavrilova & Hopland, 2018).

Proposed Merger of Local Government Councils in Australia

From the figure 1, it can also be perceived that the tax burden of tobacco largely lies on the consumer. Tobacco being a luxury product, have low elasticity (Boadway & Song, 2016). From the figure 1, it can be seen that the demand curve is highly inelastic and exhibits that with change in the price, there will be little amount of alteration in the demand. As the price rises, there will be lower accounting of change in the demand and it provides the producer free hand to shift the tax burden to the consumers (Tarantilis et al., 2015). From the figure 1, it can be seen that the yellow coloured zone represents the consumer burden and the green coloured zone is the tax burden of the producer, whereas, due to the imposition of tax, there will be a certain amount of deadweight loss that has been highlighted by the red coloured zone in the diagram. Comparing the tax burden of the producer and consumer, it can be seen that the most of the burden has been faced by the consumer due to the fact that that tobacco is luxury good and it highly inelastic to price change.

When it comes to the price elasticity of demand then it represents the change in quantity demanded with the change in the price (Friedman, 2017). If the price elasticity of demand of a product is relatively low, then it can be said that the change in demand is low compared to the change in price, which can be seen in the case of the luxury product. Tobacco being the luxury product showcase inelastic demand that represents the price change will be higher compared to the change in demand (Johnson, 2017). Considering the own price elasticity, it can be seen that the percentage change in quantity demanded of tobacco is lower than the percentage change in price of the same that allows the producer to shift the burden of the tax from itself to the producer.

According to the latest proposal from the state governments around Australia, it would be better to merge the local government councils and the rationale behind this is under critical consideration since then. Though the main factor of this lies within the huge cost incurred by the council to maintain its working framework, however, it needs detailed analysis. According to the Zeedan, (2017), margining the local government is meant to enhance the economies of scale of the authority and in addition to this it is aimed to enhance the functional capabilities of the local authorities. Though in brief, however essential details regarding the rationale of this unification is mentioned below:

Operational and Cost Benefits of Merger

As mentioned earlier, lowering the fixed cost is one of the major reason for the merger of the local authorities. Levy, (2015) has argued that, local authorities of the Australian government need huge amount of money as their fixed cost. Most of the cost goes in maintain the building and the other things in good condition that cause a loss to the national income.  Thus, with the merger of the local authorities, it can be expected that the fixed cost, which is the higher amount of cost within every stipulated time by the local authorities, will be reduced. As the figure 2 highlights, in addition to this, as the fixed cost lowers, it will reduce the average variable cost too   due to the optimal resource allocation (Boardman et al., 2017). It will help both the local and the central government to save huge amount of cost of operation.

Figure 2: Average fixed cost

Source: (Du et al., 2014)

Long run average cost is the representation of the performance of a business. From figure 2 it can be seen that, as the economy moves, long run average cost starts to reduce and the economy moves towards the increasing returns to scale. Considering the case of the merger of the local authorities of the Australia, it can be said that as the firm merge, it will lower the cost of operation and thrive forward the combined agency to have economies of scale (Atack, 2018). It will further reduce the cost of operation and help it to attain efficiency in performance.

Figure 3: Long run average total cost

Source: (Du et al., 2014)

Though it is evident that cost of operation is one of the main reason for the proposed merger, however, according Petersen & Kumar, (2015), besides the operational cost factor there is operation factor too, that has driven the notion of merger to come up. With all the governmental local agencies under one roof, it will be better for the customers as well as service providers to provide better service within a short period of time (Dinan, 2017). It will further help the agency to aid the customers with higher efficiency, which is another aim of this merger.

Considering these facts, it can be said that management is certainly good move by the local authorities. It will reduce the price of operation, enhance the serviceability and the efficiency of the organisation that will further reduce the price of operation. Thus to conclude it can be stated that the rational lies behind the economies of scale and the operational parameters.

Reference:

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Excise rates for tobacco. (2018). Ato.gov.au. Retrieved 21 April 2018, from https://www.ato.gov.au/Business/Excise-and-excise-equivalent-goods/Tobacco-excise/Excise-rates-for-tobacco/

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