A question on cigarette taxes
I am doing a little research project estimating the elasticity of demand for cigarettes. This is to help lawmakers see the effects of increasing the state tax rate on cigarettes. In doing this, I have estimated the effects of state cigarette tax rates on state cigarette prices. After controlling for several other factors, I have estimated that, holding these other factors constant (controlling for their variation), that for every 1-cent increase in state cigarette tax rates, the price in the state goes up by more than 1 cent, by about 1.12 cents. The correlation is extremely strong, and I am confident the rate of increase in prices is no smaller than 1.09 for every 1 cent increase in state tax rates.
I am sure that this is correct in terms of both my statistical estimation AND economic theory, though it does not exactly mesh with the somewhat simpler theory we saw in chapter 8. So my first question is why is this counter to the theory in the first part of chapter 8? For the first correct answer to this question posted here on the blog, I will give double the points I usually give.
Now for the second question: “What is the reason for this suprising result?” Hint: the answer has to do with what has been termed the “3rd law of demand.” For the first correct answer to this question, I will give FOUR times the usual blog comment points. Be the first on your block to win!
-MC
April 28th, 2009 at 8:54 pm
In chapter 8 we saw the excess burden. The excess burden is the amount by which the burden of a tax exceeds the tax revenue received by the government- the deadweight loss from a tax. It is counter to the theory in ch. 8 because it is flipped. Every 1 cent increase the price in the state goes up. In ch. 8 we learned that the excess burden exceeds the tax revenue.
The 3rd law of demand holds that a fixed cost added to a good of varying quality causes the consumer to prefer the higher quality rather than the lower. Most people stick to name brand cigarettes. If the price rises they will not care because consumers stick to brandnames. People will purchase what satisfys his or her wants
April 29th, 2009 at 12:37 pm
my comment has not so much to do with the question asked, but simply just me commenting on the above topic, i believed that it was in March that Pres. Obama sign the bill to increase tax on cigarettes from 0.39 to 1.01 per pack as well as cigars to pipes.Chewing tobacco from 19.5 to 50 cents a pound. The total expected to be raised over the 4 1/2 year-long health insurance expansion is nearly $33 billion. it is estimated that over 440,000 premature deaths are a result from smoking,which costs the economy over 190 billion dollars. the tax is a terrific health move, about one in five adults in the us smoke cigarettes, with a tax increase we should see that percentage dwindle.
April 29th, 2009 at 10:25 pm
In the material discussed at the beginning of chapter 8 we talked about how we could measure the inefficiency of tax. We learned that a tax creates a deadweight loss and this is called an excess burden of the tax. The burden of a tax exceeds the tax revenue that is received by the government. This is why the statement is counter to the theory viewed in the first part of chapter 8.
The result is surprising because of the theorem of the 3rd law of demand, which state that any value added as a fixed cost to goods with differences in qualities would cause the purchase of the product of higher quality. In this case, if the price rises consumers will still buy the product without a doubt.
April 29th, 2009 at 10:52 pm
Jimmy,
You are so close to getting these big extra points. Close, but just now yet. I will give you another hint: When a good is taxed, how much of the tax do the buyers pay? the sellers? Another hint: the answer has nothing to do with deadweight loss. Oh, Wolfgang and Jimmy, when the price of cigarettes increases, people still reduce their purchases, but the third law says they will shift toward quality. Hmmmm?
-MC
April 30th, 2009 at 6:07 pm
The tax imposed on the good will not change the demand that the smokers will have for the good. If the price of the good increases the purchasing of the product will decrease.Which will leave a paying the majority of the taxes to either the buyers or the sellers.
April 30th, 2009 at 11:32 pm
At the beginning of chapter 8 we talked about how we could measure the inefficiency of tax. We learned that a tax creates a deadweight loss and this is called an excess burden of the tax. A tax imposed on the good will not change the demand that the smokers will have for the good. The 3rd law of demand holds that a fixed cost added to a good of varying quality causes the consumer to prefer the higher quality rather than the lower. At the rate of tax on cigarettes, it doesnt matter what name brand they buy. Consumers will continue to buy it even if the cigarette is a lower grade.
May 4th, 2009 at 3:09 pm
When a good is taxed the majority of the tax is payed by the consumer. The goverment can tax the seller and the sellers tax the consumers.
According to Alchian and Allen Theorm The 3rd law of demand states that by reducing the price of higher quality relative to lower quality versions of the same good, a fixed transportation charge will trigger a predictable shift in the mix of quality grades purchased by consumers in distant markets, as compared to the mix purchased locally. This means that if higher grade cigarettes were cheaper people would buy them, but since they are not people buy chaeper ones that are similar to the name brands they are use to.
May 12th, 2009 at 9:27 pm
In chapter 8 we discussed the inefficiency of tax and I learned that the demand for cigarettes will not change when a tax is imposed on it. The 3rd law of demand states the reducing the price of higher quality relative to lower quality versions of the same good.I believe this means people will buy to the demand of there life’s.