What is the effect of an indirect tax on the cigarette market?

Cigarettes are considered a demerit good since its consumption has a negative impact on the consumer. The product then results in an external cost as it becomes a cost for a third party as a result of an economic transaction. Thus, the MPB of cigarette consumption is greater than the MSB which proves the cigarette market to be a negative externality of consumption. 
In an attempt of ‘internalising the externality’, a government can decide to tax cigarettes by a certain amount, let's say 2.5 US$ (P/unit + 2.5$). It is therefore an indirect specific tax as it is implemented by the government on a good and is a tax per unit. The tax increases the MPC and shifts private supply to the left. This has the beneficial effect of reducing consumption of cigarettes to the optimum level of Q*. The supply curve for cigarettes shifting vertically upwards by the amount of the per-unit tax from S ( to Stax. By doing so, the cigarette consumers and producers are involved in paying the costs to society instead of the third party. MPC shifts back to intersect with Q* (S - Stax), decreasing the amount sold and raising the market price to Ptax. This brings the market from Ptax and Qtax in line with the optimal amount of output at Q*.

Answered by Economics tutor

12159 Views

See similar Economics IB tutors

Related Economics IB answers

All answers ▸

Why do firms in a perfect competition always make normal profit in the long run?


Explain the effect on GDP of an expansionary monetary policy (10)


How might an increase in average income levels affect the average price level?


Outline the differences between the GDP, real GDP and green GDP.


We're here to help

contact us iconContact ustelephone icon+44 (0) 203 773 6020
Facebook logoInstagram logoLinkedIn logo

© MyTutorWeb Ltd 2013–2025

Terms & Conditions|Privacy Policy
Cookie Preferences