Chapter 18 Tobacco and Alcohol

Chapter 18Tobacco and AlcoholChapter OutlineAN ECONOMIC MODEL OF TOBACCO AND ALCOHOLWHY IS REGULATION WARRANTEDTAXES ON TOBACCO AND ALCOHOLEconomic Impact of Beer and CigarettesBeer IndustrySales $17 billionEmployees 33,000 Cigarette IndustrySales $27 billionEmployees 20,000The Simple Model SupplyDemandQ*P*PTobacco/AlcoholABC0Value to the Consumer: 0ACQ*Consumers Pay Producers: OP*CQ*The Variable Cost to Producers: OBCQ*Consumer Surplus: P*ACProducer Surplus: BP*CWhy Regulation is WarrantedTo provide information or to correct for the inability of consumers to make good decisionsExamples: restrictions on advertising of tobacco, warning labels, age restrictionsTo deal with externalities (effects of a transaction that hurts or helps people who are not a part of that transaction) Examples: drunk driving and second-hand smokeImmorality of a good (not a justification economists often use)Example: prohibition Ads and the Information ProblemWhaaazzuupp (how ya doin)Joe CamelNASCAR Winston Cup, Busch Series (Car sponsors Miller, Budweiser, Kodiak)Virginia Slims TennisThese ads appeal to children (whether or not they are intended as such).ExternalitiesTobacco accounts for approximately $1 per pack in costs incurred by taxpayers and nonsmokers.Medicare, Medicaid, Asthma, Drunk Driving accounts for one-third of the 37,000 traffic accidents that cause 40,000 deathsModeling ExternalitiesSMarginal CostD(Marginal Benefit)Q*P*PTobacco/Alcohol0Social CostExternal CostQ’P’A Twist on the Externalities Argument for TobaccoCigarette smokers are more likely to die at an earlier age than they would have otherwise died.in a less costly manner than they would have otherwise died. (e.g. heart attack rather than Alzheimer’s.)Some economists estimate that this effect saves Social Security, Medicare and Medicaid (because they are not in nursing homes) more money than the $1 per pack in estimated external costs.Using Taxes to Correct for ExternalitiesSMarginal CostD(Marginal Benefit)Q*P*PTobacco/Alcohol0Social Cost=S+taxExternal Cost=taxQ’P’The Tobacco Settlement and Why Elasticity Matters1998 settlement between several states and several tobacco companies$250 billion spread over 20 yearsDemand for tobacco products is fairly inelastic. This means that the percentage change in prices will be more than the percentage reduction in smoking.A Tax on Tobacco with Inelastic DemandSMarginal CostD(Marginal Benefit)Q*P*PTobacco/Alcohol0S+taxtaxQ’P’Elasticity EstimatesElasticity of Demand for Tobacco-.2 for adults-.5 for childrenFor Beer-.53ImplicationsA dollar increase in the tax on cigarettes would reduce consumption by adults by 10% and reduce consumption by children by 25%.