Date posted: Friday, April 12, 2013 | Manila, Philippines
Why is demand for cigarettes inelastic?
USUALLY, when the price of a product is raised, demand for that product declines. This rule, however, does not seem to apply to cigarettes, which continue to remain in high demand no matter how much their prices are raised.
Jonathan L. Cellona
So what explains the “price inelasticity” of cigarettes?
The price elasticity of demand measures consumers’ sensitivity to price changes. “Elasticity will measure how much quantity of a good will be purchased by consumers after a price increase. If the price of Good A, for instance, will increase to P12 from P10 and consumers will decrease their consumption of that good to 14 units from 15 units, the elasticity coefficient can measure how consumers responded to the increase in price,” said Ramon Benedicto N. Marcelino, economist and former senior tax specialist at the ...view middle of the document...
When there are close substitutes for the goods or services, demand is also elastic. Except for cigarettes. Demand for these products has been noticeably inelastic.
“This means that even if prices are raised, consumers, or smokers for that matter, will still consume almost the same number of sticks or packs of cigarettes. This is because cigarette smoking is a form of addiction and smokers cannot easily withdraw from this habit,” Mr. Marcelino pointed out.
However, a high price increase, by raising the tax, for instance, may succeed in changing consumer behavior.
“The demand for cigarettes will depend upon how much the tax rate is increased. If the current tax rate on cigarettes is increased by say, 50% or 100%, and if producers will shift the entire tax burden to consumers through higher prices, definitely it can be expected that the price of cigarettes per pack or stick may also increase by 50% to 100%,” Mr. Marcelino said.
Thus, if consumers find the increase in price of too high due to the high tax rate, they might lessen their cigarette consumption - at least in the short run. Consumers will continue to feed their addiction by looking for substitutes.
“…They will look for cigarettes that have a lower price. Therefore, on the part of the smugglers, this could be an opportunity to smuggle in more as consumers will buy lower-priced cigarettes as substitute for higher-priced cigarettes,” Mr. Marcelino said.
Whether the new excise tax law that raised taxes in January will succeed in tamping down cigarette consumption - as proponents have hoped - therefore remains to be seen.
“The objective of limiting the consumption of cigarettes by increasing the current tax rate is definitely laudable as it intends to minimize the ill-effects of smoking among smokers and non-smokers alike and also provide additional revenue to the government. Nevertheless, using the tax alone to lessen cigarette consumption may not be sufficient as smokers will always look for substitutes to their vice,” Mr. Marcelino said. -- Trishia P. Octaviano
- See more at: http://research.bworldonline.com/popular-economics/story.php?id=114&title=Why-is-demand-for-cigarettes-inelastic?#sthash.2kUCeImo.dpuf