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Literature on the Demand for Cigarettes

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This chapter is to review the existing literature on the demand for cigarettes. There is a large volume of published studies describing the price and income elasticity on cigarette consumption. Furthermore, there is also a large and growing body of literature has investigated the effects of taxes and anti-smoking regulations on the demand for cigarettes. So far, there are only a few studies regarding the relationship between aging population and the consumption of cigarette.

2.1 Demand Model

2.2. Past Research

Several studies have revealed that there is an inverse relationship between price and cigarette consumption and positive effect of income. Franke (1994) finds that Granger Causality is significant from price and income to United States cigarette consumption. There is no significant change in the estimated demand elasticity occurred during the period studied. In order to test a model of the demand for the cigarettes in United States from 1961 to 1990, he uses quarterly data and multiple analyses. The results of the study show a positive effect of income and negative effects of price. Likewise, Zheng, Zhu and Li (2008) also find that there is positive income elasticity but negative cigarette price elasticity based on the best fixed-effects spatial-temporal model. In 2008, they construct a demand equation to examine the elasticity of per pack cigarette price and per capita disposable income. They consider the cigarette demand in a spatial panel of 46 states of the United States over a 30-year period which is from 1963 to 1992. They propose a new spatial panel models and adopt a fully Bayesian approach for model parameter inference and prediction of cigarette demand at future time points using the Markov chain Monte Carlo (MCMC) algorithms.

Chaloupka et al. (2002) uses data from tobacco industry document to determine what tobacco companies knew about the impact of cigarette prices on smoking among youth, young adults and adult. They evaluate how this understanding affected their pricing and price related marketing strategies. The tobacco company documents provide velar evidence on the impact of cigarette prices on cigarette smoking, describing how tax related and other price increases lead to significant reductions in smoking, particularly among the young people. They conclude that future tobacco control efforts that aim to raise prices and limit price related marketing efforts are important in achieving reductions in tobacco use and public health toll caused by tobacco. This view is supported by Fernández et al. (2004) which report that there is an inverse relation between price and consumption of cigarette in Spain between the period of 1965 and 2000, indicating that interventions at the economic level such as real increases in price may have an important public health impact in tobacco control. Correspondingly, Gallus et al. (2006) perform a similar study to determine the influence of cigarette price on tobacco consumption in Italy. They conduct a survey on 3050 individuals aged 15 and above and find that prices had an intermediate to high influence on cigarette consumption in the young. Younger and less educated smoker were more prone to report an influence of prices. They conclude that cigarette prices have substantial influence on tobacco consumption in the young people.

On the contrary, Raptou et al (2005) argue that cigarette demand is extremely insensitive to price changes. They use the data collected via questionnaire that was administered in personal-in-home interviews and estimate a two-part model of cigarette demand [Cragg, J. G. BSome Statistical Models for Limited Dependent Variables with Application to the Demand for Durable Goods,^ Econometrica, 39, 5, 1971, pp. 829Y44.]. They conclude that cigarette price measures do not influence cigarette demand but smoking restrictions in workplaces and educational establishment and most of the psychosocial variables are found to affect cigarette demand.

According to Huang and Yang (2006), recent estimates of the income elasticity of cigarette demand have pointed a disturbing result which is a nearly zero or sometimes negative income elasticity. They employ a four-regime panel model (dynamic fixed effect) to estimate the cigarette demand function in United States in order to explore the nonlinearity embedded in the cigarette demand structure. They apply a multi-regime model to 47 states using data from 1963 to 1997. They claim that there is a nonlinear relationship between personal income and cigarette consumption. Evidently, as income rises, cigarette has become an inferior good. The results from the four-regime model suggests that income elasticity is negative when per capita income is greater than US$ 8,568 but become positive though insignificant when income above US$ 18,196. In the income range between US$ 8,568 and US$ 18,196, the income elasticity is significantly negative. There is a nonlinear relationship prevailed for the price elasticity.

Furthermore, Martinez, Mejia, and Estable (2008) states that the long term's demand for cigarettes in Argentina is affected by the changes in real income and real average price of cigarettes. They analyze the data based on monthly time-series data between the periods of 1994 to 2004. The result shows that when the prices increase in a 120%, maximum of revenues from the cigarettes tax can be obtained and also a big impact in the fall of the total consumption of cigarettes in the country. Similarly, Abedian (2000) also states that there is an inverse relationship between the price and consumption of any good which include cigarettes.

This negative relationship further affected by other factors like income levels and the degree of addiction. He argues that tobacco consumption is increasing a developing country problem and it could bring harm to the people. He also argues that there are no adverse economic consequences following such policy framework.

In 2000, Joni Hersch states that smoking behavior responds to changes in price, not unlike many other economic commodities. He finds that higher prices reduce cigarette demand for both men and women with respect to smoking participation and cigarette consumption levels, with elasticity ranging from -0.40 to -0.60. In contrast to other studies, he finds that the price elasticity is similar for men and women. Income has negative effect on smoking behavior. He also states that excise tax policies can deter smoking, but their effects will be largely restricted to the low income segment of the population. This result suggests that there might be a constructive response by smokers to informational efforts that warn about the dangers that environmental tobacco smoke poses to others, particularly when it is members of one's household.

Further observed that increased in taxes also play a big role in reducing the cigarette consumption. In recent years, there has been an increasing amount of literature on higher prices that result from increased tax lead to significant reductions in cigarette smoking. A recent study by Chaloupka et al (2010) are to provide empirical evidence on the effects of the cigarette excise tax structure on three outcomes which are the cigarette prices, government revenue, and cigarette consumption. They compose cross-sectional time-series data for 21 European Union (EU) countries from year 1998 to 2007 from various data resources. The estimates suggest that the greater reliance on the ad valorem excise tax leads to lower average cigarette prices and larger price gaps between premium and low-priced cigarette brands. In addition, these impacts from the tax structure are smaller in more concentrated or less competitive markets. They also propose that greater reliance on a specific tax has greater impact on cigarette smoking, but the impact diminishes with the growth of manufacturers' market power.

In view of this, Peng and Ross (2009) estimates the sensitivity of Ukraine population to cigarette prices and the affordability of cigarettes using the macro level data in order to predict the effectiveness of cigarette tax policy. They use a monthly time-series data from 1997 to 2006 in Ukraine to estimate the generalized least square (GLS) model with an AR(1) process. The result shows that the cigarette price is not significantly associated with legal domestic sale of cigarette. Higher household income and more active outdoor advertising have positive and significant impact on cigarette sales. There is also a positive relationship between the affordability for cigarette and legal domestic cigarette sales. Increasing the cigarette excise tax by 10% would increase the cigarette price by 3%. This demonstrates that cigarette tax policy can be used to regulate cigarette price in Ukraine. The population is found to have relatively low sensitivity to cigarette prices and cigarette taxes, even though of low magnitude but the impact of cigarettes affordability is statistically significant. Similarly, Lee et al. (2005) conclude cigarette price elasticity estimate to be less than one, meaning that although the tax will have some effect in reducing cigarette consumption, it will also generate additional tax revenues.

Moreover, Hidayat and Thabrany (2010) study the demand for cigarettes through a myopic addiction model and use it to estimate the price elasticity of cigarette demand in Indonesia. They use an aggregated panel data taken from three waves of the Indonesian Family Life Survey over the period of 1993 to 2000. They propose that the short run and long run price elasticity of cigarette demand are estimated at -0.28 and -0.73 respectively. Price increases had a negative and significant impact on cigarette consumption. Increasing cigarette prices via excise taxes can control tobacco use and thus raise government revenue. They conclude that excise taxes are more likely an effective tobacco control in the long run rather than a major source of government revenue.

Besides that, Lee (2008) uses cross-sectional study on 483 valid questionnaires completed during a telephone survey of current smokers aged 15 years and above from all 23 major cities and countries in Taiwan from April to July 2004. This study analyses the willingness of current smokers to quit smoking or reduce cigarette consumption when faced with a tax increase of NT $22 per pack which would raise the price of cigarette by 44%. The Tobit regression model and the maximum likelihood method were used to estimate cigarette demand elasticity. The estimation results yielded a cigarette price elasticity of -0.29 in connection with a 44% increase in the price of cigarette. The most significant response to the price increase was found among women, low income smokers, moderately addicted smokers and smokers who regularly purchase low-price cigarette. He concludes that since the current cigarette prices are low in Taiwan and smokers are relatively insensitive to cigarette price hikes, a large increase in cigarette tax would reduce cigarette consumption effectively and would also increase the government cigarette tax revenue and cigarette merchant's income. This result is consistent with the findings from previous studies by Townsend (1996) and Sissoko (2002) which reflects the price has major effect on cigarette consumption and thus smoking induced disease especially in low income groups. Progressive increases in cigarette tax rates provide a powerful contribution to policy for reducing cigarette consumption and generate extra government revenue.

Consequently, Ross and Al-Sadat (2007) estimate the price and income elasticity of cigarette demand and the impact of cigarette taxes on cigarette demand and cigarette tax revenue in Malaysia, they find that income was positively related to cigarette consumption. A 1% increase in real income increased cigarette consumption by 1.46%. They use time series regression analysis for 1990 to 2004 applying the error-correction model. The per-capita consumption of domestic and imported cigarettes was calculated using the excise tax and import duties collected by the Malaysian government and the size of the adult population which are aged above 15 years old. The model predicted that an increase in cigarette excise tax from RM 1.60 to RM 2 per pack would reduce cigarette consumption in Malaysia by 3.37%. They conclude that taxation is an effective method of reducing cigarette consumption and tobacco-related deaths while increasing revenue for the government of Malaysia.

According to Huang, Yang, and Hwang (2004), future cigarette consumption will depend entirely on tax share, price and income elasticity of remaining heavy smoker. They use panel unit root test to estimate the demand for cigarettes over the period of 1961 to 2002 for 42 states and Washington,D.C. The cigarette data used in this study are obtained from “The Tax Burden on Tobacco published by the Tobacco Institute”. They find that price and income elasticity are approximately -0.41 and 0.06. Besides that, decreasing tax elasticity gives rise to decreasing price elasticity, and smaller tax shares seem to be related to declining tax elasticity. This study has an interesting implication, which is cigarette consumption is a normal good to wage earners and transfer payment recipients, but an inferior good to the owners of stocks and the elderly population.

In 2002, Hu and Mao have analyzed a policy dilemma in China on public health versus the tobacco economy through additional cigarette tax. In order to estimate the impact of tobacco production and consumption on government revenue and the entire economy, they use published statistics from 1980 to 1997. Imposition of cigarette tax increase will have a significant effect in generating additional central government revenue and reducing cigarette consumption. Therefore, increasing additional tax on cigarettes would be beneficial to the Chinese government from both the financial and public health perspective.

Levy, Cummings, and Hyland (2000) develop a simulation model to predict the effects of taxes on the smoking rate and smoking-attributable deaths. The method used in their study projects the number of smokers and smoking-related deaths from a baseline year 1993. They find that increase in taxes is to reduce the percentage of the total population that smokes. Youth experience greater effects. The effects of a tax hike tends to increase over time as younger individuals who are more responsive to a price increase grow older, but federal and state taxes on cigarettes are currently set at a fixed amount per unit. Moreover, the price of cigarettes falls relative to the purchasing power of the population as wages increase. These effects grow over time and lead to a substantial savings in lives and health care cost.

Lanoie and Leclair (1998) investigate the relative ability of two anti-smoking policies which are taxes and regulations in inducing reductions in cigarette consumption and in providing incentives to stop smoking. The results based on a Canadian data over the period of 1980 to 1995 show that cigarette demand responds to taxes with the elasticity of -0.28, not regulation. This result suggests that both policies are acting in a complementary fashion to influence the incidence of smoking.

In addition to that, Galbraith and Kaiserman (1997) analyze Canadian cigarette consumption and taxation between 1980 and 1994. During that period, there is a large price rises and declines, and a dramatic increase in the consumption of the contraband tobacco products. In their study, they examine the elasticity of legal cigarette sales and total sales which include contraband with respect to the price of legal cigarettes and various other factors. They conclude that the price elasticity of demand for cigarettes has tended to increase in absolute value over time, making taxation an increasing strong instrument with which to influence smoking behavior. In considering untaxed sales as well, it becomes clear that the sensitivity of total cigarette sales to the taxation instrument is much lower than would otherwise appear, and has fallen obviously.

According to Meier and Licari (1997), increase in federal tax is more effective than increases in state taxes in reducing tobacco use. Cigarette consumption also decline when health warning labels were added. They use a pooled time-series analysis from 1955 to 1994 with 50 states as units of the analysis. The impact of excise taxes on cigarette consumption for several different models and econometric techniques is asset to examine the effectiveness of state and federal taxes in reducing the consumption of cigarettes and estimate the impact of government health warnings. Their study also shows how warnings and taxes interact.

Tobacco control programs also has some impact towards the consumption of cigarettes as stated by Farrelly, Pechacek and Chaloupka (2003) that increase in tobacco control program expenditures reduce cigarette sales. In addition, in reviewing the evidence on the effectiveness of comprehensive tobacco control programs, the recent Surgeon General's Report on Reducing Tobacco Use concluded that comprehensive tobacco control programs work. Although these studies have consistently suggested that state tobacco control programs decrease tobacco use, these studies could have easily been confounded by changes in excise taxes, cross-border sales, and other factors.

Nevertheless, Leu (1984) demonstrates that anti-smoking publicity in the mass media in Switzerland has had a substantial permanent impact on cigarette consumption. It is a powerful tool to reduce cigarette consumption. He concludes that extended publicity, following the 1964 US Surgeon General's Report, accompanying various tax increases and preceding a public vote on an advertising ban for tobacco products, decreased consumption permanently by 11%. It is supported by Keeler et al (1993) which analyses the effect of prices, taxes, income and anti-smoking regulations on the consumption of cigarettes in California. They use monthly time-series data for 1980 through 1990. He also states that the long run effect of the increase in tax will be to reduce cigarette consumption. Anti-smoking regulations reduce cigarette consumption, and that consumers behave consistently with the model of rational addiction.

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