Question

Tax policy is one of the most effective means for the reduction of tobacco products consumption as it is confirmed in almost all relevant studies carried out so far by the leading researchers in the field of health economics. In order to determine the effect of cigarette prices increase, it is necessary to estimate price elasticity. Evidence from countries of all income levels suggests that increase in cigarette prices is highly effective in reducing demand. Previous research, conducted in low and middle-income countries, found that the price elasticity of demand for cigarettes is in the range of −0.5 to −1. In the U.S., the price elasticity of demand for cigarettes in 2020 is estimated to be −0.6, while price elasticity of supply is 6. What portion of the specific (per unit) tax on cigarettes is paid by smokers in the U.S.?

Answer 1

Answer - The elasticity of demand and elasticity of supply helps to determine the amount or the share of tax , paid by the consumer and the seller. The side with greater elasticity will pay less and vice a versa. As given in the above problem , elasticity of supply is 6 , and elasticity of demand is -0.6. Since the demand is inelastic in nature , major portion of tax will be paid by Consumer and seller will bear less tax as supply is elastic in nature.

Since , elasticity of demand is just 1/10th portion of elasticity of supply , 90% portion of tax will be paid by consumer and remaining 10 % will be paid by seller.

Hence , if per unit total tax is $ 10 , then $ 9 tax will be paid by Consumer and $ 1 as tax per unit will be paid by seller.