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Lecture Issues in economics today - Chapter 18: Tobacco and alcohol

In this chapter students will be able to: Apply the supply and demand model and the concepts of consumer and producer surplus to the markets for tobacco, alcohol, and illegal goods and services, conclude that economists endorse interference in a market for reasons related to the information and costs to innocent third parties, utilize the concept of elasticity of demand to analyze who gets hurt by taxes on tobacco and alcohol, analyze the impact of drug legalization. | 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 Employees 20,000 The Simple Model Supply Demand Q* P* P Tobacco/Alcohol A B C 0 Value to the Consumer: 0ACQ* Consumers Pay Producers: OP*CQ* The Variable Cost to Producers: OBCQ* Consumer Surplus: P*AC Producer Surplus: BP*C 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 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). 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 Modeling Externalities SMarginal Cost D(Marginal Benefit) Q* P* P Tobacco/Alcohol 0 Social Cost External Cost Q’ P’ 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. Using Taxes to Correct for Externalities SMarginal Cost D(Marginal Benefit) Q* P* P Tobacco/Alcohol 0 Social Cost=S+tax External Cost=tax Q’ P’ 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. A Tax on Tobacco with Inelastic Demand SMarginal Cost D(Marginal Benefit) Q* P* P Tobacco/Alcohol 0 S+tax tax Q’ P’ 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%.