Tag: Smoking policy

(Photo from Reuters via the Wall Street Journal)

Supports: Microeconomics, Chapter 6, Section 6.3, Economics, Chapter 6, Section 6.3, and Essentials of Economics, Chapter 7, Section 7.7.

In August 2023, an article in the Wall Street Journal discussed the effort of the German government to reduce tobacco use. As part of the effort, the government increased the tax on tobacco products, including cigars and cigarettes. The tax increase took effect on January 1, 2022. According to German government data, during 2022 the quantity of cigars and cigarettes sold declined by 8.3 percent. At the same time, the tax revenue the government collected from the tobacco tax declined from €14.7 billion to €14.2 billion.

1. From this information, can you determine whether the tobacco tax raised the price of cigars and cigarettes by more or less than 8.3 percent? Can you determine whether the demand for cigars and cigarettes in Germany is price elastic or price inelastic? Briefly explain.
2. According to the Wall Street Journal article, in addition to increasing the tax on tobacco products, the German government took other steps, including banning outdoor advertising of tobacco products, to discourage smoking. Does this additional information affect your answer to parts a.? Briefly explain. 

Solving the Problem

Step 1:  Review the chapter material. This problem is about the effect of price changes on revenue, so you may want to review Microeconomics, Chapter 6, Section 6.3, “The Relationship between Price Elasticity of Demand and Total Revenue,” or the corresponding sections in Economics, Chapter 6 or Essentials of Economics, Chapter 7.

Step 2: Answer part a. by explaining whether you can tell if the tobacco tax raised the price of cigars and cigarettes by more than 8.3 percent and whether the demand for cigars and cigarettes in Germany is price elastic or price inelastic. We have two pieces of information: (1) In 2022, the quantity of cigars and cigarettes sold in Germany fell by 8.3 percent, and (2) the revenue the German government collected from the tobacco tax fell. We know that if a company increases the price of its product and the total revenue it earns falls, then the demand for the product must be price elastic. We can apply that same reasoning to a government increasing a tax. If the tax increase leads to a fall in revenue we can conclude that the demand for the good being taxed (in this case cigars and cigarettes) is price elastic.  When the demand for a good is price elastic, the percentage change in the quantity demanded resulting from a price increase will be greater than the percentage change in the price.  Therefore, the percentage change in price resulting from the tax must be less than 8.3 percent. An important qualification to this conclusion is that it holds only if no variable, other than the increase in the tax, affected the demand for cigars and cigarettes during 2022.

Step 3: Answer part b. by explaining how the German government’s banning of outdoor advertising of tobacco products affects your answer to part a. Banning outdoor advertising of tobacco products may have reduced the demand for cigars and cigarettes. If the demand curve for cigars and cigarettes shifted to left, then some of the 8.3 percent decline in the quantity sold may have been the result of the shift in demand rather than the result of the increase in the tax. In other words, the German market for cigars and cigarettes in 2022 may have experienced both a decrease in demand—as the demand curve shifted to the left—and a decrease in the quantity demanded—as the tax increase raised the price of cigars and cigarettes. Given this new information, we can’t be sure that our conclusions in part a.—that the demand for cigars and cigarettes is price elastic and that the tax resulted in an increase in the price of less than 8.3 percent—are correct.  

Extra credit:  This discussion indicates that in practice economists have to use statistical methods when they estimate the price elasticity of demand for a good or service. The statistical methods make it possible to distinguish the effect of a movement along a demand curve as the price changes from a shift in the demand curve caused by changes in other economic variables.  

Sources:  Jimmy Vielkind, “Smoking Is a Dying Habit. Not in Germany,” Wall Street Journal, August 31, 2023; and Statistisches Bundesamt, “Taxation of Tobacco Products (Cigarettes, Cigars/Cigarillos, Fine-Cut Tobacco, Pipe Tobacco): Germany, Years, Tax Stamps,” September 10, 2023.