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Economics Ia - Market Externalities Cigarette

Autor:   •  July 15, 2019  •  Coursework  •  764 Words (4 Pages)  •  247 Views

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Cigarette is demerit goods. Demerit goods are goods that will be over provided by the market and, because of this, they will be over-consumed. They are goods that the government thinks are bad both for the people who consume them and for society as a whole, and therefore government would like to see them consumed to a lesser degree, or not at all[1]. The market of cigarette is the example of market failure.

Malaysian government had taken various initiatives to discourage people from taking up, or continuing the consumption of cigarettes. As cigarette is a demerit good, it creates market failures in Malaysia as some Malaysian consume cigarettes.  The consumption of cigarettes leads to negative externalities of consumption.

[pic 1]

[pic 2]

Figure 1

Figure 1 show the negative externalities of consumption of cigarettes in Malaysia where the Marginal Private Benefit is higher than Marginal Social Benefit.  The gap produced between Q1 and Q* creates welfare loss to the society. Malaysian government used fiscal policy in order to reduce the consumption of cigarettes in Malaysia. Therefore, Malaysian government had used contractionary fiscal policy by increasing the excise duties on cigarettes by 14% thus.

[pic 3]

Figure 2

As Malaysian government imposed indirect tax on cigarettes, Marginal Social Cost shifts upwards from MSC to MSC + tax. Therefore, it leads to increase in the price of cigarettes in Malaysia from P1 to P2. Due to the implementation of indirect tax, the consumption of cigarettes in Malaysia decreases from Q1 to Q2. Therefore, new welfare loss is obtained based on the gap produced from Q2 to Q*. Based on Figure 1 and Figure 2, the welfare loss reduced after the indirect tax is implemented. Reduced welfare loss indicates the negative externalities of consumption in Malaysia decreased.

The implementation of indirect tax will lead to higher price of cigarettes for Malaysian. Therefore, consumer will be less likely to buy more cigarettes due to higher price of cigarettes. On the other hand, it also will reduce Malaysia’s cigarettes producer revenue as consumer buy less cigarettes from the producer. In this case, it will damage the tobacco industry in Malaysia. However, Malaysian government will gain more revenue from the tax implemented on cigarettes.

The demand of cigarettes is highly inelastic. [2]Inelastic means that when the price goes up, consumers’ buying habits stay about the same, and when the price goes down, consumers’ buying habits also remain unchanged. This is due to the addiction of the consumer habit of smoking. Therefore, consumers are willing to pay at higher price in order to consumer cigarettes.

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