Effect of Imposition of Tax

Imposing higher excise tax might lead to a decrease in demand, though it might have only very little effect, as demand is price inelastic in case of goods like alcohol (Baumol and Blinder 2015). Essentially, individuals who are addicted might keep purchasing the product even when the price of the product goes up and there are also no close substitute products for the same. Alcohol is essentially a demerit good, so, individuals might underestimate the overall costs of smoking. This means that the people who consume alcohol and are addicted to the product might disregard the damage that the good causes to their health. Thus, this can be regarded as the reason to try stop individuals from consuming the good (Moulin 2014). In addition to this, consumption of alcohol and alcohol based product also has different negative externalities. For instance, the consumption of alcohol leads to increase in rates of crime, increased rates of accidents, liver and heart diseases, increased rates of accidents and many others.  Hence, the social cost of consumption of alcohol is essentially higher than the definite private cost. In this case, if the overall social cost is greater than the current price, then the overall social efficiency can be raised by necessarily making the people pay for actual social cost (Iossa and Martimort 2015).

As per the diagram below, the initial demand is represented by DI and the initial supply is represented by D2 where the equilibrium price and quantity is P1 and Q1 respectively. However, with the imposition of the tax, the supply reduces and shift from S1 to S2. The price rises from P1 to P3 due to imposition of tax and the quantity demanded declines from Q1 to Q3. As the demand is very inelastic, greater increase in prices leads to comparatively lesser amount of fall in quantity demanded. The diagram below reflects the fact that the imposition of tax leads to the shift of the supply curve from S1 to S2 leading to a decline in the demand. This can be considered to be socially efficient position as at equilibrium the social marginal cost is equal to the social marginal benefit (Rader 2014). Yet another benefit of increasing excise duty by the government on alcohol products is that it leads to augmented tax revenue. This can essentially enable the respective government of the nation to spend higher amount of money on the entire healthcare as well as campaigns for inspiring people to keep away from alcohol. Otherwise, this can also lead to decreasing the rates of taxes such as VAT. Consequently the superlative argument for raising the excise duty is essentially based on a normative judgement that consumption of alcohol is bad for the health of the people and the respective government have the need to intervene for reduction of the demand of the good. However, arguments against imposition of the tax on alcohol products is that the demand is very inelastic for this good, therefore, the rise in prices for imposition of the tax can only cause a very insignificant fall in the demand for the product (Rader 2014).

Consequences of imposing a minimum price on alcohol for the consumption of alcohol products

Figure: Effect of imposition of tax

(Source: Rader 2014)

Consequences of imposing a minimum price on alcohol for the consumption of alcohol products

The government falteringly can propose a minimum price for a particular unit of alcohol. This minimum price is mainly aimed at averting the sale of alcohol at a very cheap rate by different supermarkets. The higher price can help in discouraging drinking and in turn help in improving health and force individuals to pay true social cost of alcohol. On the other hand, economists who argue that it can be considered to be unfair and add that the regressive price can also hurt the overall living standards of the particular individuals who live on low income (Baaquie et al. 2015). Nevertheless, overconsumption of alcohol can lead to different social problems that includes increased incidence of crime, increased rates of accidents, premature deaths, liver disorders, different heart diseases and mental problems among many others.

The diagram 1 below shows that the social cost of consumption of alcohol is greater than the overall private cost. Setting minimum price at a higher level that is at P2 makes people pay the social cost of consumption of alcohol. This in turn decreases the quantity of consumption from Q1 to Q2. Thus, it can be hereby said that higher minimum price set by the government can be considered to be an important factor in handling with greater cost of alcohol consumption problem. Consequently, this discourages individuals from overconsumption.

Figure 2: Figure showing the social cost of alcohol that is higher than the private cost

(Source: Nguyen and Wait 2015)

The diagram below illustrates the economics behind setting minimum prices for alcohol products. At normal condition, demand equalises with supply at the equilibrium price Pe and at the equilibrium quantity Qe. Essentially, a normal demand and supply model asserts that a minimum price that is set above the equilibrium price can lead to a situation of surplus. Surplus hereby means that the supply becomes greater than the demand. However, in case of alcohol pricing, this will not happen as supply as well as demand are both very much inelastic. In that case, sellers of alcohol will just raise the prices to P2 and this will be associated to the reduction of quantity to Q1. Thus, this can lead to considerable decrease in different alcohol associated problems. Nevertheless, there are several ways to avert alcohol associated problems, but setting high minimum prices for alcohol can definitely exert certain influence on reduction of the overall demand of the product (Nguyen and Wait 2015).  However, this problem of alcohol consumption cannot be totally reduced by way of setting higher minimum price as demand for alcohol products are very much inelastic. This means that that change is price leads to very small change in the overall percentage change in demand as the product is price inelastic. This is so because there few or no substitutes for the product and for the addicted people consumption of alcohol can be considered to be necessity. Thus, even if the price rises above, people addicted might keep purchasing the product (Rubinfeld and Pindyck 2013).

The social cost of consumption of alcohol

Figure 3: Imposition of minimum prices

(Source: Rubinfeld and Pindyck 2013)

2.a. Firms that are monopolistic competitive does not function at their minimum average total cost since they operate with excess capacity.

Figure 4: Figure illustrating Long run equilibrium under monopolistic competition

(Source: Maurice and Thomas 2015)

From the above stated diagram, it can be understood that manufacturer would lose money if they produce more in order to attain either allocative or productive competency. Where the marginal cost of table rises beyond the Marginal revenue of $200, the firm would incur a greater cost and it would receive additional revenue (Schmidt 2017). This is the reason where the manufacture will maximise their profit by producing quantity where the marginal revenue is equal to the Marginal cost and charging price at $200.  

b. Oligopoly structure of market is entirely different from other forms of market. The characteristics of Oligopoly market are as follows;

Interdependence: One of the foremost characteristics of the Oligopoly is the interdependence of the numerous firms in the process of decision-making. For instance, if a small number of firm sizeable in nature forms the element of the industry and one of these firms commences the campaign for advertising on a big scale or designs a new product which captures the market, it will provoke countermoves among the rivals (Maurice and Thomas 2015). Hence, it is understood that firms are closely dependent upon each other.

Advertising: Under the oligopoly market, structure major change in policy of the firm is most likely to create an immediate impact on the other firms operating in the industry. Advertising is regarded as one of the powerful form of instrument for oligopolistic. A firm operating under the oligopoly market can begin aggressive advertising campaign with the objective of capturing a significant portion of the market.

Behaviour of firms: Under the oligopoly market, one of the most important aspects is the behaviour of the group. Irrespective of the number of group, each firm knows the action of the other firm and will have an impact on the group (Rios, McConnell and Brue 2013).

Competition: Under the oligopoly market, there is little number of sellers and one move made by a seller immediately creates an impact on the rivals. This enables each seller to keep a close watch on the moves of the rivals so that it can counter the move.

Barriers to entry: Since there is a keen competition in the oligopoly industry, there are no barriers to entry or exit from the firm. There are few barriers only in the long-run which restrain firms from entering into the industry.

Banks such as Westpac, NAB and common wealth banks forms the oligopolistic market in order to ensure the stability of the Australian banking system. Mobile networks such as Telstra Optus, NBN Co, and Vodafone are the brands of virtual operators and falling under the category of Oligopoly market structure.  Change in price of the mobile network firms will ultimately enable the rival companies to change their strategies as well since the cost is somewhat close to each other.

The economics behind setting minimum prices for alcohol products

c. The characteristics of Monopolistic competition are as follows

Large number of Sellers: There are large numbers of firms that are selling closely related goods; however, they are not homogeneous (Schmidt 2017). Each firm acts independently having living number of market share and individuals generally have limited control over the market place.

Product differentiation: Each firm are in the position of exercising a certain degree of monopoly through the help of product differentiation. The product of the firms is close however, they cannot perfectly substituted from other firms.

Selling price: Under the monopolistic competition, the goods and services are differentiated and the differences are making known to the buyers through selling costs (Counter 2015). Hence, selling cost forms the substantial part under the monopolistic competition.

Another characteristic of monopolistic competition is the freedom of firms to make free entry or exit from the industry during any point of time. It certifies that there is neither abnormal profit nor abnormal loss is suffered by the firm in the long-run.

Companies such as Coles and Woolworth are regarded as monopolistic competitive firms in the Australian economy. The food retail companies like Coles and Woolworth share nearly 60% of the total market share among themselves. The total amount of revenue, which was posted by the company amid them, represents $75.9 with Coles and Woolworth sharing $30 and $51.9 billion respectively. BHP Billiton is another mining company that occupies large number of market share for being the monopolistic company with total revenue of $14.7 in the financial year of 2016.

d. Duopoly can be defined as the form or market where two firms possess dominant control over the market. Conditions that are necessary for Oligopoly firms are

1. Existence of only two firms
2. Independence

Figure 5: Figure illustrating Duopoly demand curve

(Source: Sloman, Norris and Garrett 2013)

From the above stated market, demand curve it is understood that if a firm enters into the duopoly market the firm will produce at Q1 level because producing at this level marginal revenue will be equal to the marginal cost. This will enable the firm to charge price at P1, which is considered as the monopoly price (Bernanke, Antonovics and Frank 2015). This will help in maximising the profit. When Company B enters into the market, it will produce at Q2 level in order to maximise their revenue and charge higher price.

Figure 6: Figure stating Duopoly cost curve

(Source: Taussig 2013)

From the above stated figure, it can be understood that the company produces products at Q1 and the price rises to the level of P1. This will represent that it is the ideal time for both the firms and the joint production by both the firms represents a monopoly output and charge monopoly prices. By taking into the considerations that the presumption of equal cost is 0 the market will be equally shared between the two firms and eliminates the entry for the third firm.   

Reference

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Counter-Narratives, A., 2015. Principles of Economics. The Oxford Handbook of Africa and Economics: Volume 1: Context and Concepts, p.303.

Iossa, E. and Martimort, D., 2015. The simple microeconomics of public?private partnerships. Journal of Public Economic Theory, 17(1), pp.4-48.

Maurice, S.C. and Thomas, C., 2015. Managerial Economics. McGraw-Hill Higher Education.

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