2023 JPJC J2 H2 EC Prelim P2 Suggested Answers

Jurong Pioneer Junior College (Economics Department) 1 Question 1 With rising income and influence of media, there is a rising consumption of cigarettes. To reduce the rising consumption, Singapore imposes in direct tax on cigarettes while Philippines introduces minimum price for cigarettes. (a) Explain how each of the abov e policy affects consumers’ expenditure on cigarett es. [10] (b) Using demand and supply analysis, discuss wheth er indirect tax or minimum price is more effective in reducing quantity of cigarettes sold with rising income and influence of media. [15] a) To reduce the negative effects due to consumptio n of cigarettes, government can either raise tax or set a minimum price. This will result in a r ise in price and hence discourage and reduce consumption of cigarettes. However, the impact on c onsumer expenditure (Price x Quantity) depends on the PED value of cigarettes. An indirect tax can be imposed on the cigarettes to discourage consumption of cigarettes. With a rise i n tax, this will increase the unit cost of production on the producers. Less profit will be made with the same selling price. Hence, firms will be less able and willing to supply a good at any gi ven price. This shifts the supply curve for cigarettes leftwards from S 1 to S 2 as shown in Figure 1. As cigarettes is quite additive in nature, the demand for cigarettes tends to be price inelastic. With a fall in supply, price rises and quantity demanded falls by less than proportionate. Hence total expenditure for consumers rises. Before tax, consumer expenditure is shown in the area 0P 1BQ 1. After tax, consumer expenditure rises from 0P 1BQ 1 to OP 2AQ 2. Hence, an indirect tax on cigarettes will result in consumers paying a higher price and given that the demand is price inelastic, consumer expenditure will rise. In general, the demand for cigarettes as a whole is price inelastic. However, with the introduction of electronic cigarettes, they may be viewed as substitutes for the traditional cigarettes. Hence, the demand is for cigarette may be price elastic. Price of cigarettes S2 Quantity of cigarettes D1 P1 S1 Q2 Q1 0 P2 A B Figure 1 Price of cigarettes S2 Quantity of cigarettes D1 P1 S1 Q2 Q1 0 P2 A B Figure 2

Jurong Pioneer Junior College (Economics Department) 2 In this case, with a fall in supply, price rises an d quantity demanded falls by more than proportionate. Hence total expenditure for consumers will fall. Before tax, consumer expenditure is shown in the area 0P 1BQ 1 in Figure 2. After tax, consumer expenditure falls from 0P 1BQ 1 to OP 2AQ 2. Hence, an indirect tax on cigarettes will result in consumers paying a higher price. Whether consumer expenditure will rise or fall will depend on the price elasticity of demand for cigarettes. To discourage the consumption of cigarettes, govern ment can also set a minimum price. A minimum price is a price set above the equilibrium price, making the price of cigarettes to rise Before government impose a minimum price, consumer expenditure is shown in the area 0P 1BQ 1 in Figure 3. After imposing a minimum price at P 2, the consumers’ expenditure rises to OP 2AQ 2. This has the same effect of an indirect tax. Hence, with a minimum price set on cigarettes will result in consumers paying a higher price and given that the demand is price inelastic, consumer expenditure will rise. In conclusion, both indirect tax and minimum price will result in higher prices and lower quantity. Whether the consumer expenditure will rise or fall will depend on the elasticity of demand for cigarettes. Given the demand tends to be price inel astic, consumer expenditure is expected to rise. Price of cigarettes Quantity of cigarettes D1 P1 S1 Q2 Q1 0 P2 A B Figure 3 Minimum price

Jurong Pioneer Junior College (Economics Department) 3 b) Given a rising income and influence of media, wh ether indirect tax or minimum price is more appropriate in reducing the quantity of cigarettes sold will depend on how effective these policies are considering the benefits, costs and any unintended consequences of these policies. With rising income, the demand for cigarettes will rise assuming that the cigarettes is a normal good. Given the influence of media, advertising encourage consumption of cigarettes and changes the taste and preference of consumers and hence increase the demand for cigarettes and make the demand more price inelastic. With a rise in ind irect tax, it raise the unit cost of production of firms causing the supply to fall and shift to the l eft. With a rise in demand and a fall in supply for cigarettes, price rises while quantity is uncertain. Assuming the demand rises more than the fall in supply, both price and quantity will rise P 1 to P 2 and Q 1 to Q 2 respectively, making indirect tax ineffective in reducing the quantity of cigarettes sold as shown in Figure 4. Hence, the effectiveness of an indirect tax in reducing cigarettes consumption will depend on the extent of the shifts in the demand and supply curve. Whether a minimum price is effective in reducing co nsumption of cigarettes will depend on the amount of minimum price set and the extent of the s hift in demand due to rise in income and influence of media. Whether a minimum price is effe ctive in reducing consumption of cigarettes will depend on the change in demand. With a minimum price P 2 set above the equilibrium price P1, it forces the firms to sell cigarettes at P 2. Quantity sold will fall from Q 1 to Q 2. Assuming the demand rises to a large extent from D 1 to D 2, quantity will rise from Q 2 to Q 3, making minimum price ineffective in reducing the quantity of cigarettes sold as shown in Figure 5. However, if the demand rises to a small extent from D 1 to D 2, quantity will fall from Q 1 to Q 3, making minimum price effective in reducing the quantity of cigarettes sold as shown in Figure 6. Price of cigarettes S2 Quantity of cigarettes D2 P1 S1 Q2 Q1 0 P2 Figure 4 D1 Price of cigarettes Quantity of cigarettes D2 P1 S1 Q2 Q1 0 P2 Figure 5 D1 Q3 Minimum price

Jurong Pioneer Junior College (Economics Department) 4 Whether a minimum price is effective in reducing co nsumption of cigarettes will depend on the amount of minimum price set. With a minimum price set at P 2 and demand shift from D 1 to D 2, the quantity of cigarettes will rise from Q 1 to Q 2, making minimum price to be ineffective in reducin g quantity of cigarettes. However, if the minimum price is set higher at P 3, then quantity will fall from Q1 to Q 3, making minimum price to be effective in reducing quantity of cigarettes. Hence, the effectiveness of setting a minimum price in reducing cigarettes consumption will depend on the extent of the minimum price set. Over all, the effectiveness of setting a minimum price, given a rise in demand, in reducing cigarettes consumption will depend on 1) the extent of the shifts in the demand and 2) the extent of the minimum price set above the equilibrium price. Both indirect tax and minimum price aim to reduce t he quantity of cigarettes sold. However, the effectiveness of the policies will depend on the YE D, benefits, cost and any other unintended consequences that the policies may bring about. Th e effectiveness of the policy will depend on the YED for cigarettes. If the demand for cigarettes is income inelastic and with a rise in income, the rise in demand may be insignificant compared to a fall in supply due to indirect tax. Hence, reducing the quantity of cigarettes sold may be effective. On the other hand, if the YED for