[Economics] Smoking 1

Main questions
What are the major questions that economists try to answer in the tobacco industry? Dates back to the 1950s, analysis at the time was motivated by the degree of price elasticity of demand of cigarettes, and the government's interests regarding the concentration of the market (industrial organisation matters). Subsequence analysis focused on health related issues. More emphasis was stressed on how economic forces influence the consumption of tobacco, and whether government should intervene (or how much). An emerging stream called Behavioural Economic helps explain the empirical evidence collected as well.

In economics, the focal point has always been on the relationship between prices and cigarette consumption (demand). Retail prices could be affected by the amount of excise tax government levy on cigarettes. Here are a few very much debatable issues of tax on cigarettes:
Equity of tax - Is cigarette tax a regressive taxation, and if so how much?
Efficiency - How is society welfare affected?
Arbitrage issues - Smuggle and black market?
Cross price elasticity - How the demand of other tobacco products are affected by raising cigarette price?

First of all, we have to ask what factors are fundamental in affecting people's behaviour to smoke? Monetary price is certainly one of them, and this is the physical amount that smokers have to pay in order to obtain the product. However, there are other costs associated with smoking for consumers. Time is one of them, and restrictions and laws in place are another. Limits to access would also impose a greater private cost of smoking. New information from health science also raise the perceived long term costs of smoking.
In addition to costs, advertisements, taste, preferences, and income also affect cigarette demand. A more or less counter-intuitive observation has been found linking income and cigarette consumption. Intuition tells us that if income rises, consumption on a product should rise (i.e. the product is a normal good). However, observations tell us another story, that cigarette is in fact an inferior good.

Individuals weigh all these costs against benefits when deciding whether to smoke (at least that is what we believe rational people do, and the assumption of rationality has always been a contestable issue).

Monetary Price
What role does monetary price play on cigarette demand? Price elasticity of demand is estimated (for overall cigarette demand) to be ranging from -0.3 to -0.5. The fact that more addictive smokers are less responsive to prices also makes intuitive sense.

How to model addiction? Do smokers maximise utility over past, present and future (i.e. are rational)? Or are they myopic, in the sense that they discount future infinitely, and only make trade-offs now?
Price responsiveness is affected by time preference. Addicts with high discount rates (care much about future utilities) will be relatively responsive to changes in money price. Therefore, it might be the case that younger, and lower income persons will be relatively responsive to changes in money prices.

Behavioural economics approach:
Studies examine the impact of price, which is defined as the effort required to receive a dose of a drug, on the amount of addictive substance intake. Outcomes are mostly consistent, with PEOD of -0.56, an inverse relationship between price and cigarette smoking.

Next, we will investigate another closely related issues other than monetary price, which is tax.