Tobacco Industry Tax

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Tobacco Industry: Economy and economic influences

Economic influences that can affect the tobacco industry in a negative way:

Inflation will have a negative impact on the tobacco industry because the nominal cost of cigarettes will increase as a result of which, the nominal prices will also increase. Thus, the demand for the tobacco industry will gradually decrease. (Federal Trade Commission Evaluation of the Tobacco Industry Analysis Submitted to Congress on October 8, 1997)

High inflationary situation will discourage the manufacturers to take risks that are involved in investing for future reduction. Also, during inflationary period, people are encouraged to hoard large stock of goods because it is quite profitable. This will lead to a reduction in the supply of goods and will ultimately lead to black marketing.

Besides this, the increase in the tax rates will also have a negative impact on the tobacco industry because the prices of tobacco will increase leading to a decrease in the demand of tobacco.

How the economy affects the success of the tobacco industry

The US economy is in a state of recession. The value of dollar in terms of other currencies is falling significantly. The growth in the U.S. economy has slowed down since last spring owing to the housing slump. Presently, the US economy is facing tough competition from the new growing economies such as China and India. These countries are joining together with other countries like Russia and Brazil, in terms of business, to form BRIC.

This will ultimately impact the tobacco industry because during recession, the prices will fall and the demand will initially remain the same but will diminish slowly.

Besides, the government intervention in the market will also affect the demand for tobacco in the market and ultimately the success of the tobacco industry. Suppose the government sets a maximum limit or a price ceiling for tobacco, the manufacturers would have to sell their products at that price and can not raise the price above that. Thus, it will adversely affect the growth of the tobacco industry.

Shifts and price elasticity of supply and demand

Though, there are many substitutes of tobacco that are available in the market and more and more people are becoming aware of the harmful effects of tobacco, but still the demand for tobacco is expected to increase by the year 2010. It is known that the substitutes of tobacco also cause tumors if used for a long period of time. The prices of the tobacco substitutes have increased and as a result, there has been a shift in the demand curve for the tobacco industry because the demand for tobacco has increased. There will be an upward shift in the demand curve. Also, there will an upward shift in the supply curve because the price of tobacco is expected to increase due to the increase in the tax rates. When the price will increase, the supply will also increase.

The demand for tobacco is inelastic; i.e.; the demand for tobacco will change with a change in its price but not proportionately. The change in the demand will be less than the change in the price. The elasticity of supply is also inelastic; i.e.; change in supply will be less than the change in price.

Positive and Negative Externalities

Positive externalities

Majority of the production externalities are positive for the tobacco companies. Tobacco symbolizes a large cash crop and it generates employment for several people. Tobacco is grown and made relatively pollution free. The economies of several localities depend on tobacco. On the whole, the production of cigarettes and tobacco leads to creation of jobs and fetch money for the localities.

Negative externalities

Cigarettes and the tobacco industry are plagued by a number of negative demand externalities. The key externality is the health risk linked with them. Every year, over 400,000 people die due to various heart diseases, cancers, and strokes that are caused directly from smoking. Smoking and smokers face several other negative externalities, such as not being able to smoke in most public buildings. (Market Description) The people who do not smoke have to suffer from the smoke that is released while smoking; this smoke is really harmful for those who are inhaling it though they do not smoke.

Fiscal and Monetary policy of the Tobacco Industry

The effect of the monetary policy on the tobacco industry can be illustrated through the following example. For example, if the bank rate is increased, the investment in the tobacco industry will decrease and the output and growth in the industry will simultaneously decrease and the prices in the tobacco industry will increase. As a result, the employment rate will also decrease. Thus, a contractionary monetary policy will adversely affect the employment rate, output and growth of the industry.

An example has been given to show the effect of the fiscal policy on the tobacco industry. After increasing the tax rates on the tobacco products, the prices of alcoholic beverages and tobacco group raised by 6.51% percent every month; the annual inflation rate for the group reached a level of 17.21%. Or, it can be said that about 0.85 % points of the annual CPI inflation aroused from the prices of tobacco. (SUMMARY OF THE MONETARY POLICY COMMITTEE MEETING, 2007)

The fiscal policy also has a significant effect on the output and price of tobacco. If the fiscal policy is tightened and the taxes are increased, it will significantly affect the tobacco industry. (The Complete Text of the Report of the Koop-Kessler Advisory Committee on Tobacco Policy and Public Health, 2003) If the excise taxes on tobacco products are drastically increased and it is indexed to inflation, the employment rate in this industry will decrease and the growth will also decrease. The price of tobacco will increase; as a result, the consumption of tobacco will automatically decrease.


Federal Trade Commission Evaluation of the Tobacco Industry Analysis Submitted to Congress on October 8, 1997. Retrieved June 13, 2008

Market Description. Retrieved June 13, 2008


The Complete Text Of The Report Of The Koop-Kessler Advisory Committee On Tobacco Policy And Public Health (Dec. 2003). Retrieved June 12, 2008

Dwivedi, D. N. (2004). Managerial Economics, New Delhi: Vikas Publishing House Pvt. Ltd.

Siddiqui, S. A. (2002). Economics: National Income Accounting and Introductory Economic Theory, 3rd Edition, New Delhi: Laxmi Publications Private Limited.

Mathur, N.D. (2003). Business Economics (2nd Edition), Jaipur: Shivam Book House Private Limited.