ESSAY WRITINGIN ECONOMICS

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To what extent are indirect taxes the most effective way to correct the market failure caused by smoking cigarettes? Knowledge and understanding Demerit goods – information failure - worse for individual than they realise (causes diseases such as lung cancer) and also imposes externalities on third parties such as illness from passive smoking and increased costs to NHS Demerit goods – over consumed  over produced  too many scare resources allocated to their production  allocative inefficiency (MSC > MSB) & therefore market failure Indirect tax – tax imposed on a good via the producer – can be used to discouraged production and consumption

To what extent are indirect taxes the most effective way to correct the market failure caused by smoking cigarettes? Analysis Diagram (ACCURATE) Then use labels in diagram in analysis

To what extent are indirect taxes the most effective way to correct the market failure caused by smoking cigarettes? Analysis (The Economics) continued Indirect tax imposed by government  increase in costs of production  less willing and able to supply at each price  S to S1 increase price P to P1  contraction in demand and quantity demanded and supplied falls from Q to Q1 This reduces the over-consumption of demerit good and moves the market equilibrium to a more allocatively efficient level where MSB = MSC and thereby correcting the market failure caused by the cigarettes. Effective if Demand is price elastic as  P  large fall in Qd Raises revenue for government which can be hypothecated towards treatment of effects of smoking

To what extent are indirect taxes the most effective way to correct the market failure caused by smoking cigarettes? Analysis continued (counter analysis) However Does not tackle information failure Revenue may not be hypothecated Not effective of PED inelastic

To what extent are indirect taxes the most effective way to correct the market failure caused by smoking cigarettes? Alternative Methods Regulation – e.g. banning cigarettes – but this mean government acting in a paternalistic way and not enabling citizens to make their own value judgements Provision of information – but again this could be ignored

To what extent are indirect taxes the most effective way to correct the market failure caused by smoking cigarettes? Evaluation Make sure you reference question (use same wording so that it signals to the examiner you are answering the question, and also helps you stay on track) Indirect taxes can be the most effective way of correcting the market failure caused by smoking cigarettes if demand for them is price elastic. However, given their addictive nature, this is unlikely to be the case. I therefore believe that they would be more effective if combined with information provision from the government (and indeed the tax revenue could be used to fund this). This combination would reduce quantity demanded through the higher prices reducing over-consumption, and resolve some of the information failure thereby correcting the market failure.

Homework Rewrite one of the essays from this summer’s microeconomics paper Hand in next Monday / Tuesday (this lesson next week) Make sure your analysis is ACCURATE