Does taxation and negative advertisement impact cigarette demand

Taxation is one of the most common policies used by the government to reduce demand of any product. Taxes increase the price of the goods which leads to reduced demand. Goods such as cigarettes have negative externalities and affect the society as a whole. Government uses such policies to reduce such negative externalities and help gain welfare in the society. To check whether this statement is valid my research is based on it. The data I collected and my research was done in my locality Jogeshwari. This data will be analyzed and will help me to come to a conclusion. The research includes questions asked to a retailer and to 60 questions to consumers who visited his shop. It covers both consumers and producers perspective. My research will also analyze if taxation and negative advertisement have any effect on the consumption of cigarettes and come to a conclusion based on my research question which is: Does taxation and negative advertisement have any impact on the demand of cigarettes in Jogeshwari (west), Mumbai?

According to me an increase in taxes should reduce the consumption of cigarettes as people will have low purchasing power so demand will fall. People with low income will be more affected than people with high income therefore to some extent it should prevent market failure. Also this will increase government’s revenue to a great extent. I also think that negative advertisement is also a good way to spread awareness and reduce the consumption of cigarettes. People are poor and illiterate in India and so spreading awareness would actually make them think of reducing consumption of cigarettes. This research will help me know a lot about the government policies and the negative externalities caused due to smoking. The data will be collected and analyzed to come to a conclusion.

Introduction:

Demand for a commodity is when consumers have willingness and ability to buy that good. The law of demand says that when price decreases demand increases keeping all other factors constant (citrus paribus). Supply is the amount of good available for the people in the market. The law of supply states that when prices increase the supply increases too keeping all the other factors constant.

Quantity demanded

The graph above shows the relation between demand and price and supply and price. Demand and price are inversely related while supply and price are directly related. When demand meets the supply in a market the market is said to be in equilibrium point. At price P the demand equals the supply and so equilibrium is attained. Demand and supply are the most important tools in economics. They determine the equilibrium in the market.

There are few goods in the market that are the exceptions. For example goods like cigarettes and alcohol. These goods are inelastic goods. The demand doesn’t fall even when the price increases. There are lots of negative externalities related to such goods. Externalities is when the market clearing price creates benefits or inflicts costs on a third party which not a consumer or a producer. Cigarettes when consumed cause negative externalities. It has several health issues. Smoking has become more of a fashion in today’s world. It is very enjoyable for the smokers but it creates a lot of social cost. They harm themselves and also to the society. They incur a lot of external cost to the society. This is in the form of passive smoking, using up the health resources which could be used for others for better purposes. “Almost Rs 300 billion from public and private funds was spent for the treatment of such diseases in 2002-03.” [1] This shows that smoking cause high direct and indirect cost on the society. Thus also gives high economic burden to the government and to the people as this money definitely exceeds the revenue collected by the taxes on cigarettes. There are many such direct causes of smoking in the society. An article in mail today says that 10% of world smokers are Indian which is over 12 crores. They say every 3rd Indian smokes with 57% being man and 11% women. [2] 

Tobacco use in India among males and females (age 15-49), 2005-2006

3

Through the graph it is very evident males and females in rural area smoke more than urban areas. But these stats include smoking bidis. According to me people in urban areas might be smoking more cigarettes as cigarettes are more expensive. People are very poor in rural areas and so for them to consume cigarettes in larger amount won’t be reasonable. People in rural area consume more tobacco of any form than urban area; this could be because most of them are illiterate and are not aware of the consequences of consuming tobacco.

Major cause of all deathly diseases is smoking. Compared to a normal person a male smoker has 23 times more chances of having lung cancer while a female smoker has 13 times more chances. It causes 90% death due to lung cancer in men and 80% in women. [4] There are few indirect costs due to smoking to the society too. Every year around 1 million people die in India because of smoking. [5] This is very bad for the economy of the country as the death caused due to smoking is between the productive age (30-60). Death of such young people could lead to loss of production and harm the economy as a whole. Also due to death of a man in a family leads to the burden on the family as he could have been the sole source of income for them.

Economic Theories

These were few of the negative externalities caused due consumption of smoking. This could be further analyzed by using a graph. The graph below shows the negative externalities of consumption of cigarettes:

Market for cigarettes

6http://anneclaireramser.files.wordpress.com/2010/04/picture-121.png

= MPC

Government doesn’t only want to decrease the number of smokers but also to reduce the negative externalities caused on the third party of the society. If you take smoking, the marginal private benefits (MPB) are higher than the marginal social benefits (MSB). This could be said because the smokers pass their cost on the society and the government. The external costs are ignored by the consumers and so marginal social benefit in lower than marginal private benefits. We can also see in the graph that marginal private cost (MPC) is equal to marginal social cost (MSC). It is the supply curve in the graph. The supply of cigarettes don’t cause any problems to the third party and so MPC = MSC. The market attains a socially optimal point when MSC = MSB when the quantity demanded in Q*. At this there is no welfare lost as social cost is equal to social benefit. When the quantity demanded is Q1 the marginal social cost is more than marginal social benefit. Every quantity produced after Q* add on to the negative externality and cause welfare loss to the society due to over allocation of resources.

To address this market failure and to increase the welfare of the society government could several policies to reduce the demand and consumption to attain the social optimal point. Firstly government could use the policy of taxation. It can impose taxes on such goods to reduce the demand. When the prices increase the demand falls as mentioned earlier. I think imposing tax on cigarettes would be a good option for the government to reduce smoking and also it will also increase the revenue of the country. WHO also recommends countries to increase the tax as it will reduce the health cause and increase productivity of the people. “Cigarette taxes account for approximately 38% of the retail price. This falls well below the rate recommended by the World Bank (from 65% to 80% of retail price) that is commonly present in countries with effective tobacco control policies.” [7] The taxes in India on cigarettes are very low compared to other countries. This makes it cheaper and so people consume it more. The prices are not set according to the inflation.

8Affordability of tobacco products in India

You can see from the graph that every year the ability of the people to buy cigarettes and any form of tobacco has significantly reduced a lot. Taxing is a very effective way to reduce consumption according to me. Higher price will discourage people to smoke and benefit the society. Statistic proves that too:

This data shows in India if the taxes are levied on cigarettes it can saves many lives and also increase the revenue. If the taxes are increased to 78% of retail price 4.7 million people would reduce smoking and 3.4 million lives would be saved. It will give India additional 146.3 billion rupees. As India is a developing country most of the people in the middle class and poor class so increase in price would definitely affect them. This theory can also be proved by the graph below:

Market for cigarettes

MPC + Taxhttp://anneclaireramser.files.wordpress.com/2010/04/picture-121.png

= MPC

Quantity demanded

The graph shows that due to addition of tax on cigarettes the marginal private cost has increased because producers have transferred the burden on the consumers by increasing the price. The MPC thus moves up. MPC now meets MPB at the point where its quantity demanded is Q* which is the optimal point. The graph shows that there won’t be any welfare loss but it isn’t true as people will still smoke and still there will be health issue and passive smoking. Externalities can be reduced but cannot be finished completely.

According to me taxing will be effective but not to a great extent as cigarettes are addictive is an inelastic good. Therefore increase in the price won’t have a drastic change in the demand for cigarettes. By increasing price we are just reducing the ability of the people to buy cigarettes but willingness would be unchanged. As we are going through an economic crisis an increase would make it difficult for people to buy cigarettes.

Another policy government could use to control the demand and negative externality is by spreading awareness and making people aware of the consequences due of smoking cigarettes. Half of the death due to smoking occurs among non educated poor people of India. Putting forward few health issues and problems of early death and cancer due to smoking cigarettes would have a definite effect on the consumption. According to me this policy should be more effective as most of the Indians in rural areas are illiterate and rather than increasing the price if you educate them and tell them about the ill effects of smoking there would be a better result. You can also represent it on a graph and prove it. Due to advertisements the MPB would move down as people would consume less now. It will come closer to socially optimal point where MSC is equal to MSB.

The facts and statistics stated above arises several questions in the mind of the readers like, does taxation affects the consumption of cigarettes? The statistics and theory show that there will be changes but will that actually happen if the policies are implied because cigarette is an inelastic good.

Research and analysis

Research: To prove and study the effect of taxation on cigarettes I made a research on the local people of Jogeshwari west. 60 people were requested to fill the questionnaire and answer few questions (attached at the last page). This data is analyzed and presented below. The data is analyzed by the answers given by few consumers and the retailer of Jogeshwari outside a shop who sells cigarettes. (pan wala)

Sex of the people smoking cigarettes

The pie chart shows that 82% (49) of the people who came to the retailer to smoke were males and only 18% (11) were females which is comparatively very less. But according to the latest tobacco atlas, India ranks 3rd in the top female smoking countries in the world. USA is first with 2.3 crore and China with 1.3 crore female smokers but compare to USA and China India has very less female smokers less than 20%. [9] Out of the 82% man from all age group bought cigarettes but it wasn’t the same for women. Out of the 18% everyone was from low income group and poor. The average age was also more than 40+for females.

Age group of consumption of cigarettes

As u can see from the above graph that cigarettes were consumed by people of every age group but most of it was consumed by the youngster exactly what I expected. Today smoking cigarettes have become more of a fashion for the youth. They try to look cool and due to some peer pressure they take up smoking. As you can see the minimum age used in the graph is 15 but during the survey I met few students who were between 13-15 years old who bought cigarettes. When I asked the retailer about kids taking up smoking he said in recent years students smoking at such early age has increased significantly. My observation was only guys at such small age bought cigarettes but the retailer added saying that there were few girls at such early age too who smoke cigarettes. “In the age group of 13-15 years, 17.3 per cent are male smokers and 9.7 per cent are female smokers.” [10] These students are the future of the country and are already creating such negative externalities at such an early age. People between 30-45 years also consumed cigarettes to a considerable extent. Only people above 45 and mainly old people consumed more of tobacco and bidi than cigarettes.

The data clearly shows that the people with income between 20,000-40,000 smoke the most. These are middle class people the main sector of our population. There is not much difference between the low earners, student and middle class people. As said earlier students and kids smoke quite a lot and the table clearly proves it. There were only 10 people who had high salaries and came to buy cigarettes. It is also possible that this group people might have bought it in bulk. Lower income people also consume cigarettes but as per the retailer they mostly buy Indian cigarettes and not imported. This also shows that cigarette is very addictive and people of any income group consume cigarettes.

Amount people spend in a week on cigarettes

Also when asked about their weekly spending on cigarettes the answer was not surprising. This question was related to the income group because people who had high income spent more than 600 on cigarettes. As cigarettes are cheap in India most of the people spent 400-600 rupees. There were many people who spent less than 200 in a week on cigarettes.

My next question to the people was whether they were aware of the harmful effect cigarettes has on themselves and to the society.

When asked if they were aware of the ill effects caused due to smoking more than 50% of the people knew partially that they were causing negative externality. 30% of the people were totally aware of the consequences of smoking and its effect and only 13% were not aware of passive smoking and the negative externality they were causing to the third party. This shows that even though when most of the people know the social cost and health cost behind smoking they would still continue smoking. When asked why they don’t stop smoking when they are aware, they replied saying they are addicted to it and it is very difficult for them to quit. This shows the inelasticity of cigarettes and people cannot stop smoking by themselves so by adding tax and forcing them to pay more would definitely help them reduce smoking.

This leads me to my next question which is; would you reduce consumption of cigarettes if the prices increase?

Out of 60 people who were asked if they would reduce smoking if prices increase 50 of them said no and 10 people said yes. As we know the most consumers of cigarettes are between 15-30 years old people and income group of 20,000-40,000 rupees therefore an increase in price would not affect them. Only people of very low income will reduce smoking cigarettes. When I asked the retailer about reduction in demand if prices increase, he completely denied it. He said there will be no change and people will still smoke cigarettes. This shows that the government policy of taxation would not be very effective as people would still continue smoking. Cigarettes are cheap and increase in price won’t affect the consumers. These consumers are ready to pay any amount and this shows that cigarettes are highly inelastic. This is shown in the diagram below:

Inelastic demand for cigarettes

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The graph shows the inelastic demand curve of cigarettes. When the taxes are levied on cigarettes the prices have significantly increased from P2 to P1 but the quantity demanded by people has changed from Q2 to Q1 which is very less comparatively. This is good for the government in a way that revenue gain is more than revenue loss. The reason why it is inelastic is because cigarettes are addictive and cheap. An increase in price would reduce the purchasing power of the people but they would purchase it.

Next question was, since how long have they been smoking cigarettes the data I received was like this:

From the graph we can see that most number of smokers were beginners and this could be as most of them were students and youngsters. People are consuming it for more than 15 years. People are causing negative externality since very long. Even though there are more people who are consuming cigarettes in recent years from 0 to 5 years but still there are many people who are consuming cigarettes since very long. Smokers are addicted to cigarettes and any increase in price would also have no effect on their consumption as they are long term consumers. The firms would make profits and government would have more revenue.

Also when asked if any of their family members or friends were affected by smoking cigarettes, 12 of them said yes and 48 said no. Only 12 people’s family members and friends were affected and so not many people are aware of the pain smokers go through. People might know the consequences of smoking but a close experience or negative advertisements might make people more aware of the social and health cost of smoking.

This leads to my next and last question which is, do negative advertisements regarding smoking reduce your consumption of cigarettes?

The graph shows that 22 people would reduce smoking due to negative advertisement and by making them aware of the negative externality. There are many people in rural areas who are very poor and illiterate. They are not aware of the social cost and health cost. This graph also shows that comparing it with the graph of effect of taxation this policy is more efficient and would give a better result. There won’t be any extra revenue collected by the government but still the consumption would reduce.

Conclusion

The study above shows that both the policies implied by the government to reduce the demand is not very effective. Few consumers and a retailer were used to collect data and analyze them. The above results are based on this sample. The above research proves that the 1st policy of taxation is not very effective because it was unable to deal with the negative externalities caused in the society. By levying tax on cigarettes only government has benefits as they get extremely high revenue. Rather than reducing the negative externality it has become for like an earnings for the government. This research creates few questions in the mind of the readers like; is taxation actually a good policy to reduce consumption? Is it good for the country if the government is receiving high revenues? Will this revenue be used for the betterment of the country? Such questions keep arising. We have also noticed that cigarette is inelastic and so consumers are consuming whatever happens for their private benefits regardless of the social cost while producers are just enjoying the profits. We have also come across that smoking among youngsters have become very common. They are the future of the country and this won’t help in the development of our country. The second policy of negative advertisement is also not effective as expected. The policy was still more favored by the people. This policy was more successful of reducing the negative externalities. There is no profit for the government in this policy and this was because of the poverty in India.

India is a developing country and if we continue to only think about the private benefits it will be difficult for us to grow. Private firms are thinking about their profit, government too is happy with high revenue while no one is considered about how to reduce the welfare loss in the society. In this research the theories were proved incorrect because taxation didn’t have much effect on the consumers and same with advertisements. Government should come up with new policies to deal with such in elastic goods. The sample data was collected by 60 people which is very small to come to a strong conclusion.