Water Scarcity, Pricing, And Tax

Demand management through pricing

1.

a.An increase in demand along with a fixed supply of water creates a shortage of supply. The supply short creates an upward pressure on price (Fine 2016). This is described in the figure below.

Figure 1: Effect of an increase in water demand

(Source: as created by Author)

The rise in demand causes a rightward shift in the demand curve from DD to D₁D_1. The suppliers can supply only 22.50 million waters per day. This makes the supply curve vertical. The effect of increased demand thus entirely fell on price which accounts a large increase from P* to P_1.

b.Water being one of the basic necessity generally has an inelastic demand. Even with a higher price people cannot adjust their demand for water much. The water however is used for various purposes. A good that have several alternative uses has a greater flexibility in demand. When price of water rises to a very high level people stop wastage of water and reduce use of water as much as possible. This makes demand elastic after at certain price ranges (Cowen and Tabarrok 2015). Another factor that might contribute to an increase in elasticity of residential water is availability of water from alternative sources. If people find, it is less costly to obtain water from some neighbored region then the residential water demand might become elastic at certain price range.  

c.

Figure 2: Effect of excise tax on water suppliers

(Source: as created by Author)

In the figure, demand for water in the community is shown by the downward sloping curve D₁D_{1. ­}The upward sloping curve S₁S₁ shows the relation between water supply at each level of price. The equilibrium in the market is E with price of water being P1 and equilibrium amount of water is W₁. The excise tax on water suppliers cause an upward shift of the supply curve by an amount equivalent to tax (Baumol and Blinder 2015). After tax, market equilibrium shifts to E₁ where new supply curve S₂S₂ meets the demand curve D₁D₁. Consequently, buyers pay a price of P₂. As suppliers now needs to pay a tax to the government, effective price for seller is much lower at P_1. The demand for water is relatively inelastic in nature. Being basic necessities, people cannot adjust their demand much with respect to price. As a result, the incidence of the tax fell more on buyers than that on seller.

Effects of an increase in water demand

2.a.

Pizzas	Fixed costs	Variable costs	Total costs	Marginal costs	Average total costs	Average variable costs
0	$1,000	$—–	$1,000	$—–	$—–	$—–
200	$1,000	$360	$1,360	$2	$6.80	$1.80
400	$1,000	$840	$1,840	$2	$4.60	$2.10
600	$1,000	$1,440	$2,440	$3	$4.07	$2.40
800	$1,000	$2,160	$3,160	$4	$3.95	$2.70
1000	$1,000	$3,000	$4,000	$4	$4.00	$3.00
1200	$1,000	$3,960	$4,960	$5	$4.13	$3.30
1400	$1,000	$5,040	$6,040	$5	$4.31	$3.60
1600	$1,000	$6,240	$7,240	$6	$4.53	$3.90
1800	$1,000	$7,560	$8,560	$7	$4.76	$4.20
2000	$1,000	$9,000	$10,000	$7	$5.00	$4.50

 b.

Figure 4: Marginal cost, average total cost and average variable cost curve

c.Yes, there are increasing return to scale. Over the range of output 0-800 average total cost continues to fall. This constitutes an increasing return to scale (Fine 2016).

d.For output level beyond 800, average total cost starts increasing. From this level of output production constitutes a decreasing return to scale (Nicholson and Snyder 2014).

3.

The heavy consumption of sugary sweetened beverages are major cause of obesity and other associated diseases like type 2 diabetes. This has become a major problem across the world. As estimated in 2014, there were more than 600 million adult people in the world suffering from the obesity in. The corresponding estimate for children under 5 years is 42 million in 2013. By 2025, this number is projected to reach to 70 million (cnn.com 2016). If the present situation persists then there will be at least one obese for every five adults. Like tobacco and alcohol, sugar thus has become a matter of public health concern. Many state attempts to control the consumption of sugar by imposing a tax on sugary drinks and other sugary products. Government belies that when a product is taxed then it not only reduces sale of the product by increasing price but also sends an indirect signal that the concerned item is harmful for health (Armstrong, Fourie and Rich 2016). Following demand-supply model can be used to understand how a sugar tax can affect consumption and sales of sugary soft drinks.

Figure: Effect of a sugar tax in soft drinks market

(Source: as created by Author)

The figure above describes scenario in the soft drinks market. With no tax, the demand for soft drinks is shown by DD. The supply of soft drinks is shown by the upward sloping curve SS. The supply and demand curve meets at A, which is the equilibrium point in the market. Q* amount of drinks are sold at a price of P*. Now, in order to control consumption of sugar, suppose a tax of ‘T’ is imposed on sugary drinks. The immediate effect of the tax is to reduce the supply of sugary drinks (Ruff and Zhen 2015). The contraction of supply is shown as a leftward shift of the SS curve by the amount of tax. Given the demand curve DD, the new equilibrium under tax is at B. Because of taxation buyers pay a high price of P_B while sellers receive a low price shown as P_S. In the new equilibrium the sales of soft drinks reduce from Q* to Q_T. This is how the taxation tool is expected to work in reducing sales of sugary products.

Elasticity of demand for residential water use

In order to fully understand the effect of a sugar tax, the study of elasticity is important. The incidence of tax and division of tax burden depends on the elasticity of soft drinks and other sugary items. The elasticity of soft drinks in most of the cases is found to be price elastic. That is demand is more sensitive to a change in price (Wordley et al. 2017). The elasticity though varies across developing and developed nations, but overall the demand is price elastic. Studies found that in Chile, price elasticity of demand is -1.37 while in Australia demand elasticity is estimated to be -0.63 (theconversation.com 2018). One reason for soft drink demand to be price elastic is the availability of substitute for sugary soft drinks. The cross price elasticity of demand for soft drink or other sugar sweetened beverages is generally high. The elastic demand results in a larger reduction in consumption following an increase in price after imposition of tax.

In order to reduce consumption of sugary drinks, the alternatives of taxation are community based intervention programs and social awareness programs like health or education campaign. The community based interventionist strategies aim to engage the whole community in activities that can address the factors contributing to weight gain. Such strategies include building playground or sport facilities, arranging counselling for families at risk and encouraging overweight children to go visit doctor and others. Several countries have adapted obesity prevention campaign to fight against obesity (Johnson 2017) In these campaign people are informed in a humorous and thoughtful way that a one can of soft drinks can contain up to sixteen pack of sugars. A combination of mass media campaign, regulation and policies could be undertaken to prevent obesity. The awareness programs inform people about the problem of obesity and identifies potential areas of changes in the lifestyle to restrict weight gain (theguardian.com 2018). These policies as against taxation can reduce obesity without imposition additional price burden or social distortion associated with tax.

Several countries have already undertaken a policy of taxing sugary drinks. In 2013 for example, Mexico implemented a 10% tax on sugar sweetened beverages. As a result of tax cost of production of such products raised by 10%. A study by British journal has found that following tax the purchase of sugary drinks decreased by 6% within the next year of tax implementation. The tax raised the sales of substitute like water or non-tax beverages by 4% (cnn.com 2016). The result of sugar tax though offers beneficial result in some countries, there is another side of such policy. After tax, some people might switch to produce drinks at home. The main problem with taxation is that it does not improve health condition of poor families rather they become unhealthier and poorer than pre-tax situation. In 2011, Denmark imposed a tax on saturated fats. The tax however failed to reduce the demand of targeted product group (Nakhimovsky et al. 2016). The government therefore abolished the tax. The tax on sugary drinks is often highly contested by the beverage industry group who fight against such tax. The tax should be implemented in combination with awareness programs to fight against the mass problem of obesity.

References

Armstrong, P., Fourie, H. and Rich, E., 2016. The impact of a sugar tax on SSBs on the prevalence of obesity. Research Note 41. Stellenbosch: ECONEX.

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

Cowen, T. and Tabarrok, A., 2015. Modern Principles of Microeconomics. Palgrave Macmillan.

Davey, M. (2018). Sugar tax: why health experts want it but politicians and industry are resisting. [online] the Guardian. Available at: https://www.theguardian.com/australia-news/2018/jan/10/sugar-tax-why-health-experts-want-it-but-politicians-and-industry-are-resisting [Accessed 5 May 2018].

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

Johnson, C., 2017. Taxing times over sugar. Australian Medicine, 29(3), p.10.

Nakhimovsky, S.S., Feigl, A.B., Avila, C., O’Sullivan, G., Macgregor-Skinner, E. and Spranca, M., 2016. Taxes on sugar-sweetened beverages to reduce overweight and obesity in middle-income countries: a systematic review. PloS one, 11(9), p.e0163358.

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

Ruff, R.R. and Zhen, C., 2015. Estimating the effects of a calorie-based sugar-sweetened beverage tax on weight and obesity in New York City adults using dynamic loss models. Annals of epidemiology, 25(5), pp.350-357.

Senthilingam, M. (2016). Can a sugar tax stop obesity?. [online] CNN. Available at: https://edition.cnn.com/2016/08/31/health/sugar-tax-obesity/index.html [Accessed 5 May 2018].

The Conversation. (2018). Another day, another anti-obesity campaign, but will this one work?. [online] Available at: https://theconversation.com/another-day-another-anti-obesity-campaign-but-will-this-one-work-11724 [Accessed 5 May 2018].

Wordley, V., Lee, H., Lomazzi, M. and Bedi, R., 2017. The sugar tax–An opportunity to advance oral health. British dental journal, 223(1), p.11.