Excise Tax Rates on Tobacco and Tobacco Products

There is an excise duty (tax rate) is as follows Australian Taxation Office, (2018)

Price Elasticity refers to the degree to which the demand a good is price sensitive. i.e. if a small increase in the price, reduces the demand disproportionately (greater than 1), then the demand for the god is highly price elastic. Similarly, if the demand for the good is relatively unaffected, then the price elasticity is low. (Less than 1) (Mankiw, 2008)

It is measured as:

E^D_{P =} Proportionate change in demand/ proportionate change in per unit price.

Figure 1  Price Elasticity of Demand

Source: (Samuelson & Nordhaus, 2006)

In the diagram above, as the price drops from P₁ to P₂, the demand (and consequently output) moves from Q₁ to Q₃. The ratio of (P₂-P₁)/(Q₂-Q₁) is the elasticity of demand. The reverse effect is seen as price increases from P₁ to P₃. Output falls fromQ₁ and Q₂ and hence the (P₃– P₁/ Q₁– Q₃) elasticity will be negative.  

Figure 2 Various kinds Price Elasticity of Demand

Source: (Chauhan 2009)

According to international research, generally, the elasticity of demand for cigarettes in Western Countries is less approximately -0.4.  (Tobacco in Australia, 2018)Thus, the Price Elasticity of demand for cigarettes is low (Panel 2 of Figure2). Hence, an increase in the tax would not reduce the demand in the same proportion. (Mankiw, 2008) Tobacco consumption has decreased significantly in Australia and taxation has played a role in this transformation. (Australian Bureau of Statistics, 2013)

Figure 3 The Effect of Taxes on Tobacco Based Products (Example: Cigarettes)

Since, the demand is not expected to reduce to a great extent, if the price changes considerably, the seller can afford to pass it on to the consumer, Thus, the consumer will have to pay a higher price of the cigarette. The implication of this is that the consumer will either be forced to pay more or decrease consumption. The benefit of this is received in the form of greater public health. Additionally, given that the demand for cigarettes is highly inelastic and the demand is not expected to shrink much, there is the possibility of additional revenue to the government. (Mankiw, 2008)

a) Fixed and Variable Costs

1. Marginal Costs is calculated as the cost of the “last unit produced  i.e Current Total Costs – Previous Total Costs for every level of output.(Chauhan, 2009)
2. Average Variable Cost, here, is taken as the average of the Marginal Good Produced and the Total Output. (Chauhan, 2009)
3. Average Total Cost: The Average Total Cost is taken as the Total Cost divided by the output. (Chauhan, 2009)
4. Variable Costs have been taken as the Marginal Cost divided by the Output.

Table 1 Various Production Costs Associated with cigarettes

The price of a product is also, the marginal revenue of the product.

In the short run, the producer will produce up to a point where the Marginal Revenue = Marginal Cost. At production level of 8 units and 2 units, the Marginal Cost is 40 which is slightly higher than the Marginal Revenue. Hence, the production level will be either 3 units or 7 units.

Demand and Supply Model on Tobacco Products

At the production level of 3 units, the Total Revenue of the good will be :

Total revenue = Price X Output

= $(35 X3)

 = $105.

 However, at this level, the total costs are at $170.

Hence, the Profits are

Profits = Total Revenue – Total Costs

= $170- $105

= – $65.

There is a net loss of $ 65 at this level.

At production level  of 7 units, the Total Revenue is

Total revenue = Price X Output

Total revenue = $35 X 7

= $245

At this level , the Profits are

Profits = Total Revenue – Total Costs

= $245- $260

= – $15

Hence, the seller will stop production at 7 units since the seller is trying to minimize losses.

In the long run, the  producer will produce where the average cost (long run average cost) is the lowest. This is at output level 8 and 7. Since, the Marginal costs is lowest at 7, the producer will still produce 7 units.

a)  Differences between Monopolistic and Oligopolistic Market Structures

Monopolistic Competition: a monopolistic competition is an example of an imperfect market structure. It is not a perfect competition because there a few buyers and sellers. However, it is not a perfect monopoly, since there are more than one supplier. (Mankiw, 2008)The industry of web browsers is an example of a monopolistic competition market. Web Browser Google Chrome has a large market share but there are a few other web browsers like Safari, Mozilla Firefox and Opera that also function. (Brown, 2017)

An Oligopolistic market is one wherein there are more than two producers but not many. There a fewer sellers in an oligopoly than in a monopolistic competition. (Samuelson & Nordhaus, 2006)

• There can be two types of oligopolistic structure. In oligopolistic markets, when firms co-operate to set the output or the price together, it is known as a collusive. Example, oil cartels such a OPEC.
• In an Oligopolistic structure, when firms compete instead of colluding, it is a normal oligopoly.(Mankiw, 2008)

The characteristics of a Monopolistic Competition and Oligopoly are as follows:

Table 2 Comparisons Between Monopolistic Competition and Oligopoly

Price and Output determination in a Monopolistic Competition

 Short Run Equilibrium

The firm will produce at an output which is the intersection of the  Marginal Revenue and the Marginal Cost below.

• In Figure A, minimum average cost point is higher than the demand. Hence, the firm will have super normal profits.
• Figure B, minimum average cost point is lower than the demand. Hence, again super normal profits are realized.

Figure 4 Monopolistic Competition

Source: (McConell, Brue, & Flynn, 2009)

Figure 5 Monopolistic Competition Short Run

Source: (McConell, Brue, & Flynn, 2009)

Figure 6 Short Run Equilibrium in monopolistic Competition

Source: (McConell, Brue, & Flynn, 2009)

In the long run, demand for firm’s products will lower as more firms enter the market for profits, which will erode the super normal profits. Thus, in the long run, the firm will only make profits at it’s break even point i.e where average costs equal price. (McConell, Brue, & Flynn, 2009) (Shown in diagram below)

Costs Associated with Cigarette Production

Price and Output Determination in Oligopoly

The  long-run and short run equilibrium of firms in an oligopoly are almost similar. The price and output determination is as follows:

Kinked Demand Curve:  Non Collusive Oligopoly

Figure 7 Kinked Demand Curve

Source(McConell, Brue, & Flynn, 2009)

The “kinked demand curve” is a feature of the non-collusive oligopoly.  There will always be a ruling price. If any of the firms lowers the price than this price, the other firks will follow suit. On the other hand, the other hand, if the firm raises the price to increase it’s Total revenue, then it will be priced out of the market since the competitors will have a lower price. E-commerce firms have price structures that are largely based on such a structure.

An Oligopolists demand curve is shaped by the decisions of his competitors. If the competitors match the demand curve and price which are represented as D₂  D₂   and MR₂ MR₂     in the diagram. In all likelihood, the rivals will ignore the price increase if he attempts to raise the price from QP to a higher point but will follow a price cut, if he lowers the price. Thus, the demand curve is kinked i.e  D₂ P D₁ and the Marginal Revenue is broken at MR₂  MR₁

Figure 8 Kinked Demand Curve

Source: (McConell, Brue, & Flynn, 2009)

The kinked shape of demand curve DPD and the broken Marginal Revenue Curve MRMR  explain the price inflexibility of an Oligopoly. Any change in Marginal costs between MC₁ and MC₂ cuts the short dashed vertical segment of the MR curve.

Collusive Oligopoly

In a Collusive Oligopoly, price and output setting process is identical to monopoly output and price determination since all firms are joint together like a single firm.

Figure 9 Collusive Oligopoly

Source: (McConell, Brue, & Flynn, 2009)

Each Oligopolist will charge at QP i.e above the average costs and will produce Output Q . Thus, they will have super normal profits.

Some local authorities in Australia have started merging local councils in order to form a bigger municipal council.  This would imply merging of the operations of two municipal corporations. However, empirical evidence from Australia does not present any evidence to support this theory. (McQuestin, Drew, & Dollery, 2018)

Economic Rationale

This is done so that the local councils can provide shared services and earn shared revenues. It is expected that the economies of scale enjoyed by the merged councils will help improve the services to the citizen and in some cases, may even foster innovation. (Australian Centre of Excellence for Local Government, 2011)

Differences Between Monopolistically Competitive and Oligopolistic Markets

Australia is not a very densely populated country. Hence, the total annual revenues received from a county may not be enough to cover costs. Hence, the merging will bring about economies of scale. (Mankiw, 2008)

The Average Cost Model

The Total Average Costs of running a county will decrease and the services will be share by a greater number of people and the counties will share costs of operation. There will be greater operational efficiency as the Average Factor Costs (payments as rent for land and interest for capital) may decrease. (Chauhan, 2009) Additionally, greater scale will allow counties to purchase materials in bulk. This is illustrated in the diagram below:

Figure 10 Typical Cost Curve

Source: Adapted from (Chauhan, 2009)

A typical cost curve is U shaped. . As the scale of operation increases, the costs of operation of the local government would keep decreasing. However, once there are minimum costs that would be incurred. This is point P. If the scale of operation increases beyond that, then the costs begin to rise. Hence, there might be rationale to merge a few local governments but  these mergers should be limited. Care must be taken to ensure that these mergers do not increase to a scale that the benefits of mergers are lost.

Figure 11 The Average Total Cost Curves Model

A typical U- shaped Marginal cost curve is shown in the picture above. As seen in the diagram above, generally cost curves with greater outputs have lower marginal cost curves i.e they cost of producing the last unit is lower because the total output is larger. (Samuelson & Nordhaus, 2006).

References

Australian Centre of Excellence for Local Government. (2011). ‘Amalgamations: To Merge or not to Merge?’. Retrieved from Local Government NSW: https://www.lgnsw.org.au/files/imce-uploads/90/To%20Merge%20or%20not%20to%20Merge%20-%20LGNSW%20Background%20Paper%20%28Feb%202015%29.pdf

Australian Taxation Office. (2018, March 1). Excise rates for tobacco. Retrieved from Australian Government: Australian Taxation Office: https://www.ato.gov.au/Business/Excise-and-excise-equivalent-goods/Tobacco-excise/Excise-rates-for-tobacco/

Brown, A. (2017, November 20). Google Chrome Has Some serious NEw Competition, as FireFox launches Quantum Browser. Retrieved from Express: https://www.express.co.uk/life-style/science-technology/879822/Google-Chrome-vs-Firefox-Quantum-Web-Browser-Speed

Chauhan, S. (2009). MICROECONOMICS: Theory and Applications, Part 1. New Delhi: PHI.

Mankiw, G. (2008). Principles of Microeconomics (5th ed.). Mason Ohio: Cengage Learning.

McConell, C. R., Brue, S. L., & Flynn, S. M. (2009). Economics. Irwin: McGraw Hill.

McQuestin, D., Drew, J., & Dollery, B. (2018). Do Municipal Mergers Improve Technical Efficiency? An Empirical Analysis of the 2008 Queensland Municipal Merger Program. Australian Journal of Publi Administration, doi:10.1111/1467-8500.12286 (Online acess only).

Samuelson, P. A., & Nordhaus, W. D. (2006). Economics (18th International Edition). New delhi: Tata McGraw Hill.

Tobacco in Australia. (2018). Price elasticity of demand for tobacco products. Retrieved from TobaccoinAustralia.org: https://www.tobaccoinaustralia.org.au/13-1-price-elasticity-of-demand-for-tobacco-produc