Effects Of Excise Tax On Tobacco And Cost Structure Of Firms

Impact of Excise Tax on Tobacco Products

1.The exercise duty on tobacco products on per stick of cigarette is 0.71046(ato.gov.au, 2018).

The before tax price of cigarettes is therefore

 $30 – (20*0.71046) = $30- $14.2092 = $15.79

 

Figure 1: Effect of a tax imposed on tobacco sellers

(Source: as created by Author)

The figure above describes the effect of tax on sellers of tobacco products. In case of indirect taxation, the burden of tax is divided between buyers and sellers. Sellers can easily bypass the tax burden on buyers in form of increased price. The extent of the tax burden however depends on the price elasticity of demand and supply. The price elasticity of demand is the percentage change in quantity demanded in response to a change in price. The magnitude of change in demand depends on a number of factor. Nature of the commodity is one important factor determining the price elasticity of demand (Fine, 2016). For addictive items like tobacco people tend to reduce their demand less in response to high price. The demand for tobacco products is thus relatively inelastic in nature (tobaccoinaustralia.org.au, 2018). A relatively inelastic demand implies proportionate change in demand is less than that of the change in price. The low responsiveness of demand, make the demand curve relatively steeper.

In the above figure, the demand for tobacco products is represented by the steep demand curve DD. The supply is shown as SS. Before tax the equilibrium is at E. Corresponding price is P₁ and that of the equilibrium quantity is Q₁. Suppose now a tax is imposed on sellers of tobacco products. Tax generally discourages production. The imposed tax thus shifts the demand curve to the left. The new equilibrium is set at E_1. This is obtained at the intersection of new supply curve and existing demand curve (Baumol & Blinder, 2015). At the new equilibrium, price increases to P₂ and equilibrium quantity decreases to Q_2. The P₂ is the tax inclusive price paid by the buyers. Sellers however receives a lower price of P_3. The difference in prices is the amount of tax. As clearly evident from the diagram, buyers now have to pay a much higher price as compared to equilibrium price. Because of the relatively inelastic nature of demand, buyers bear a higher tax burden than that sellers do.

2.a.

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

The short run equilibrium is in a perfectly competitive market is determined at the point where price equals marginal cost (Friedman, 2017). The given price is $35. The price lies in between the recorded marginal cost of $30 and $40 corresponding to 7 and 8 units of output respectively. Therefore, in the short run approximately 7.5 units will be produced.

Determining Short Run and Long Run Production levels

In the long run price in the competitive industry equals to the minimum point of average cost (Rader, 2014). The minimum average cost is 37.14 corresponding to an output level of 7. As the price of $35 remains below the minimum average cost the loss making firms in the long run should exit the industry.

b.Markets are segregated in different categories depending on the number of participates, degree competition and market power and other related characteristics. Monopolistic competition and oligopoly both are examples of imperfectly competitive market.

An oligopoly market is one where few sellers in the market captures a major share in the market. There are intense competition among the few firms in the market. Australian supermarket is an example of oligopoly market (Cowen & Tabarrok, 2015). A monopolistically competitive market on the other hand defines a market structure where numerous firms operate in the market, each having a considerably small market share. An example of monopolistic competition is the restaurant business.

Some major differences between oligopoly and monopolistically competitive markets are as follows

Size of market and market power

The main point of difference between the two forms of market is in terms the relative market size and market power of existing firms which is determined from the number of competitors present in the market. Because of a relatively small number of sellers, each seller in the oligopoly market enjoys greater market power as compared to monopolistically competitive market (Fine, 2016).

Entry Barriers

The few dominating firms in the oligopoly market create high entry barriers for the new firms in the industry. Different forms of entry barriers in the oligopoly market. The common forms of barriers in the oligopoly market include government authorization, resource ownership and high startup costs. In a monopolistically competitive market however no forms of barriers exist in entry or exit of firms (Cowen & Tabarrok, 2015). New firms can easily enter the industry following an above normal profit in the short run. In times of economic loss, firms leave the industry.

Because of free entry or exits firms in the monopolistically competitive market in the long run can earn only a normal profit. The oligopolistic firms on the other hands can enjoy an above normal profit even in the long run by maintaining a high entry barriers.

Geographical Area

Geographic location often becomes an important factor differentiating monopolistic competition and oligopoly. It is possible that a specific industry is an oligopoly when it is situated in small city (Fine, 2016). The concerned industry might fall in the category of monopolistic competition if it is located in a large city. 

Differences between Monopolistic Competition and Oligopoly Markets

3.The municipal amalgamation through merger between state and local government has led to a significant reduction in the number of councils in Australia. Such mergers are generally made on the ground that amalgamation comes with its inevitable economic benefits. The common rationale for these policies include benefits of economies of scales, capacity of local government, economies of scope, administrative and compliance cost (Blom-Hansen et al., 2016).

Economies of Scale  

Economies of scale implies a situation where average production cost decreases with unit increase in output. This is often argued as one primary reason or merger between state and local government. The economies of scale in reference to optimal size of city or state government refers to reduction in cost per person for the services provided by the government as with increase in the number of served population. A lager jurisdiction unit thus associated with a smaller per unit cost of the concerned services (Leigh & Blakely, 2016). In any production process economies of scales generally depend on nature of technology. The presence of high fixed cost along with a relatively small or constant variable costs, then economies of scale play an important role for expanding production.

 

Figure 2: Economies of scale from mergers

(Source: Rader, 2014)

Economies of scope

Economies of scope is another form of cost advantage associated with mergers. The economies of scope is derived from offering a wide range of goods or services from the single organization like municipal or local council.  Economies of scope particularly realizes when cost of providing a service in a single organization is considerably lower than the cost of the service if offered by several organizations. The rationale for economies of scope from merging of two governments is the reduced overhead costs from such policies. Such overhead costs for government services include cost of central administrates, computing facilities across the units of services government produces (Bell, Dollery & Drew, 2016). Henceforth, if the services are provided by the combined governmental units then total and average production cost may fall. Economies of scope thus provides arguments against existence of fragmented large municipalities.

 

Figure 3: Economies of scope

(Source: Baumol & Blinder, 2015)

Capacity of local government

The merged government body tends to have a higher level of administrative and related expertise. The state government being a large government body has access to greater specialized skills of employees that local government lacks. The local governments in Australia has to work under huge pressure of state and federal government. This leads to inefficiency in part of local governments (Schmidt, 2015). A larger government body thus enables the local municipal councils to provide a wider range of services in an efficient manner.

Administrative and Compliance cost

A valid argument in favor of mergers between local and state government is the economization of direct administrative cost and cost of compliances. The administrative cost of local government include compensation paid to the appointed and elected government officials, general staffs and overhead costs which include supplies, buildings, utilities and other items necessary to support the officials (Boyson, Gantchev & Shivdasani, 2017). The compliance cost on the other hand refers to the cost borne by voters to keep up to date regarding the policy issues, position of government, potential cost of timing and cash for registering an opinion by thee participants for hearing, voting and meeting. The joined body of government will contribute to a reduction in administrative costs leading to a greater economies of scale. 

References

Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage Learning.

Bell, B., Dollery, B., & Drew, J. (2016). Learning from Experience in NSW?. Economic Papers: A journal of applied economics and policy, 35(2), 99-111.

Blom-Hansen, J., Houlberg, K., Serritzlew, S., & Treisman, D. (2016). Jurisdiction size and local government policy expenditure: Assessing the effect of municipal amalgamation. American Political Science Review, 110(4), 812-831.

Boyson, N. M., Gantchev, N., & Shivdasani, A. (2017). Activism mergers. Journal of Financial Economics, 126(1), 54-73.

Cowen, T., & Tabarrok, A. (2015). Modern Principles of Microeconomics. Palgrave Macmillan.

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/

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

Friedman, L. S. (2017). The microeconomics of public policy analysis. Princeton University Press.

Leigh, N. G., & Blakely, E. J. (2016). Planning local economic development: Theory and practice. Sage Publications.

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-produce

Rader, T. (2014). Theory of microeconomics. Academic Press.

Schmidt, B. (2015). Costs and benefits of friendly boards during mergers and acquisitions. Journal of Financial Economics, 117(2), 424-447.