Analyse how the government may correct market failure of excess
cigarette consumption (9)
Market failure occurs when a market inefficiently allocates scarce
resources in an economy. In a situation where Cigarettes are
overconsumed which causes market failure, it is assumed that the
consumption creates negative externalities increasing the social cost.
To correct this market failure (i.e. to make it so that social cost = private
cost) the government may utilise taxation on production. These taxes will
increase the cost of cigarette production and may be passed onto
consumers increasing the price causing a contraction on the demand
curve. This will lower the quantity demand for the product. This can be
shown on the graph below.
price Supply
P1
P
Demand
Quantity
Q1 Q
At the same time, an increase in costs will cause a left shift on the supply
curve. This will result in a contraction in quantity demanded and a new
equilibrium price being established.
This decrease in demand will mean less externalities of consumption
(such as second hand smoke) and will reduce the overall social cost to a
level closer to private cost, moving towards the correction of market
failure.
Although an increase in taxation may be an efficient method to reduce
market failure, because of cigarettes addictive nature the demand curve
is relatively inelastic and therefore less sensitive to price to changes. This
means that taxation may be ineffective at meaningfully reducing negative
externalities and overall market failure.
cigarette consumption (9)
Market failure occurs when a market inefficiently allocates scarce
resources in an economy. In a situation where Cigarettes are
overconsumed which causes market failure, it is assumed that the
consumption creates negative externalities increasing the social cost.
To correct this market failure (i.e. to make it so that social cost = private
cost) the government may utilise taxation on production. These taxes will
increase the cost of cigarette production and may be passed onto
consumers increasing the price causing a contraction on the demand
curve. This will lower the quantity demand for the product. This can be
shown on the graph below.
price Supply
P1
P
Demand
Quantity
Q1 Q
At the same time, an increase in costs will cause a left shift on the supply
curve. This will result in a contraction in quantity demanded and a new
equilibrium price being established.
This decrease in demand will mean less externalities of consumption
(such as second hand smoke) and will reduce the overall social cost to a
level closer to private cost, moving towards the correction of market
failure.
Although an increase in taxation may be an efficient method to reduce
market failure, because of cigarettes addictive nature the demand curve
is relatively inelastic and therefore less sensitive to price to changes. This
means that taxation may be ineffective at meaningfully reducing negative
externalities and overall market failure.
