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Chapter 18

Chapter 18. Tobacco and Alcohol. Chapter Outline. AN ECONOMIC MODEL OF TOBACCO AND ALCOHOL WHY IS REGULATION WARRANTED TAXES ON TOBACCO AND ALCOHOL. Economic Impact of Beer and Cigarettes. Beer Industry Sales $17 billion Employees 33,000 Cigarette Industry Sales $27 billion

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Chapter 18

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  1. Chapter 18 Tobacco and Alcohol

  2. Chapter Outline • AN ECONOMIC MODEL OF TOBACCO AND ALCOHOL • WHY IS REGULATION WARRANTED • TAXES ON TOBACCO AND ALCOHOL

  3. Economic Impact of Beer and Cigarettes • Beer Industry • Sales $17 billion • Employees 33,000 • Cigarette Industry • Sales $27 billion • Employees 20,000

  4. P Supply A P* C B Demand 0 Q* Tobacco/Alcohol The Simple Model • Value to the Consumer: • 0ACQ* • Consumers Pay Producers: • OP*CQ* • The Variable Cost to Producers: • OBCQ* • Consumer Surplus: • P*AC • Producer Surplus: • BP*C

  5. Why Regulation is Warranted • To provide information or to correct for the inability of consumers to make good decisions • Examples: restrictions on advertising of tobacco, warning labels, age restrictions • To 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 smoke • Immorality of a good (not a justification economists often use) • Example: prohibition

  6. Ads and the Information Problem • Whaaazzuupp (how ya doin) • Joe Camel • NASCAR Winston Cup, Busch Series (Car sponsors Miller, Budweiser, Kodiak) • Virginia Slims Tennis These ads appeal to children (whether or not they are intended as such).

  7. Externalities • Tobacco 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 deaths

  8. Social Cost External Cost P SMarginal Cost P’ P* D(Marginal Benefit) 0 Q’ Q* Tobacco/Alcohol Modeling Externalities

  9. A Twist on the Externalities Argument for Tobacco • Cigarette 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.

  10. Social Cost=S+tax External Cost=tax P SMarginal Cost P’ P* D(Marginal Benefit) 0 Q’ Q* Tobacco/Alcohol Using Taxes to Correct for Externalities

  11. The Tobacco Settlement and Why Elasticity Matters • 1998 settlement between several states and several tobacco companies • $250 billion spread over 20 years • Demand for tobacco products is fairly inelastic. This means that the percentage change in prices will be more than the percentage reduction in smoking.

  12. S+tax tax A Tax on Tobacco with Inelastic Demand P SMarginal Cost P’ P* D(Marginal Benefit) Q’ Q* 0 Tobacco/Alcohol

  13. Elasticity Estimates • Elasticity of Demand • for Tobacco • -.2 for adults • -.5 for children • For Beer • -.53 • Implications • A dollar increase in the tax on cigarettes would reduce consumption by adults by 10% and reduce consumption by children by 25%.

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