Price Elasticity Of Demand Of Cigarettes Economics Essay

We would like to express we special thanks for gratitude to our lecturer Miss Liew to give our opportunity to learn and practise to do this wonderful project on the topic Microeconomics assignment in semester 2 during in August to December 2010. And grateful to Miss Liew for teaching and giving lecture, and her teaching structure is very interesting and it is easy to concentrate in her lecture and to know about so many new things.

A small of finely cut tobacco leaves enfolded in a cylinder of thin paper for smoking is known as cigarette. At one of the cigarettes is ignited and is allowed to smoulder; the other end it is where the smoke is inhaled, which is held in or to mouth and in some cases a cigarette holder may be used as well. Manufactured cigarettes are filtered in the most modern and include reconstituted tobacco and other addictive.

The origin of cigarette is believed that it took place in America. In America is where the production of tobacco began. It is also the place where people started consuming its leaves for smoking and chewing. The Maya civilizations were considered to be the first users in Central America. In South America, the people of Aztecs followed suite and crushed tobacco leaves, wrapped them in corn husks to smoke. During religious ceremonies, this was more popular, which is attributed to the fact that in local pottery of the region priests and deities were shown smoking through pipes.

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Price elasticity of demand (Ed) is a measure of the responsiveness of quantity demanded to change in price, in the other words, it is the ratio between a change in price and the resultant change in quantity demanded. The formula is as . The demand for a good service is elastic or relatively elastic when a given change in price is accompanied by a larger proportionate change in quantity demanded. This means the percentage change in quantity demanded is greater than the percentage change in price. The demand is inelastic or relatively inelastic when a given change in price is accompanied by a smaller proportionate change in quantity demanded. This means the percentage change in quantity demanded is less than the percentage change in price.

Referring to the diagram above, when the price of cigarettes rises from P1 to P2, the quantity demanded for cigarettes decreases from Q1 to Q2. The elasticity of the demand curve can be determined by solving the price elasticity of demand of cigarettes,, . This is because when the price of elasticity demand (PED) is less than 1, it is an inelastic demand curve diagram. The diagram is an inelastic demand curve because the price of elasticity demand (PED) is less than 1. Thus the diagram is flatter. The demand for cigarettes is inelastic because of the addiction of individual towards cigarettes. Thus no matter how much the price increases, the demand for cigarettes will only fall a bit.

The new regulations would set the minimum retail price for a stick of cigarette at 32 cent. Currently, a pack of 20 sticks cost RM 9.30 but cheaper cigarettes that cost as low as RM 4.80 per pack are available in the market. When the cigarette was set to the minimum price, that must be have some effect of setting the minimum retail price. For instance, if the demand is an inelastic, the supply of cigarette will increase and the price is allowed to fall. So, the fall in price will lead to a fall incomes to producers. When the price is effective by the minimum prices, the price must be set above equilibrium price as shown in the diagram below. This is because the government feels the price is too low in the market. Therefore, intervenes to establish a minimum price that is higher than the equilibrium price to maintain the income of producers.

When the minimum price is set, the surplus will be happen. The discourage consumption as the good is now more expensive but it will encourage the production. The production will be encourage is cause by the good is more profitable. Besides that, to overcome the surpluses resulting from minimum prices, the government may encourage the demand by buying up the surplus, advertising and finding alternative uses for the goods and cutting down on the availability of substitute.

Future of the country, government needs to increase the price of cigarettes because the move was be in line with government’s commitment to protect children and teenagers from taking up the smoking habit and exposing themselves to chronic diseases and taking drugs. This is to ensure the future generation to grow up in a healthy environment with healthy mind and body which can help in the development of the country.

Cigarettes also will lower the personality image, because many people dislike the action take cigarettes to smoke and dislike the smell around the people. People will keep away with the people who are having smoking habit. Furthermore, foreigner will not come to our country when there are many smokers and it will ruin the reputation of the nation thus the foreigner will not come to our nation to spend their expenses.

Increase the cigarettes can help low income level people. Because when these people do not have more money to purchase cigarettes and to do other thing like sport, working, volunteer.

Government may impose direct taxes or indirect taxes. Direct taxes are taxes paid by individual or organisation. Example of direct taxes is personal income tax and corporate tax. Indirect taxes are taxes on expenditure. Example of indirect taxes is taxes on goods and services. A specific tax or a unit tax is tax that does not change with price but is a fixed amount per unit sold. The taxes are based on the elasticity of the curve.

Referring to above diagram, at the initial equilibrium point a, if the unit tax is ad, total tax amount to be paid to the government is ad x 0Qo. However, the supply curve shifted to the left as a result of tax, the new equilibrium is now at point c. The amount of tax to be paid is now bc x 0Q1, which is the same as bcP1P2. Consumer tax is at P1cfP0 while producer tax is at P0fbP2. In this case, producer pays more tax than consumer. The producers will receive less profit and the consumers have to pay more.

Besides the minimum price, the other government intervene are maximum price and the per unit tax. About the maximum price, government sets this intervene to prevent them from rising above a certain level. When a maximum price is introduced, sellers are allowed to change any price up to price level but sellers are not permitted to go above it. When the maximum price is set, shortage while be occur. The maximum price will encourage consumption as the good is now cheaper but it will discourage production. It is cause by the good is less profitable to produce. In order of maximum price to be effective, government must by set below the equilibrium price as shown in the diagram below.-

Another government intervention is per unit tax. About this intervention, government may impose the direct taxes or the indirect taxes. The direct taxes are paid by individual or organization, for example personal income tax and personal corporate tax. The indirect taxes are paid by producers of the good or service to the government but they can shift the burden of the tax to consumer in the form of higher prices. When a unit tax is imposed, the production of producer’s cost will raise and shifts the supply curve upward by the same amount of tax. The diagram below is show the effect of a unit tax on supply curve.

From the above diagram, the equilibrium price of initially was Pe and equilibrium quantity is Qe. After the imposition tax, the supply curve was shifted left and the new equilibrium price is higher but the new equilibrium quantity is lower. It is clear that the effect of tax is to increase price and reduce quantity. The following diagram below is show the producer shift the tax burden to the consumer.

In this assignment, we notice that the price for the cigarettes keep changes from time to time and it is directly influence the demand of the cigarettes. As an example, when the price of cigarettes per box increases, the demand for cigarettes decreases because people are unable to afford the price of cigarettes. This will causes surplus of the stock for cigarettes in the market. When the price for cigarettes per box decreases, the demand for cigarettes increases because people are affordable to the price of the cigarettes. This will lead to shortage of the stock for cigarettes in the market. However, there will be negative when the prices of cigarettes reduced as more and more of the people addicted to smoking.

In this assignment, we learn more and more understanding about the elastic of demand and more clearly how to calculate the price elasticity of demand. Besides that, let us know the effect of setting the minimum retail price of a stick of cigarette. We also learn more about the government intervention and the effect of government intervention in the market. Furthermore, through this assignment let us more understand how to draw the diagram like maximum price, minimum price, per unit tax etc. This assignment also can let us have more confident in our final exam.