The demand for cigarettes and

other tobacco products

Anne-Marie Perucic
Tobacco Control Economics
Tobacco Free Initiative
WHO

Price (tax) increases and tobacco use

in the words of the tobacco industry
Jeffrey Harris of MIT calculated that the [US] 1982-83 round
of price increases caused two million adults to quit smoking and
prevented 600,000 teenagers from starting to smoke We dont
need to have that happen again (Philip Morris 1987).
"Of all the concerns, there is onetaxationthat alarms us the
most. While marketing restrictions and public [sic] and passive
smoking do depress volume, in our experience taxation
depresses it much more severely. Our concern for taxation is,
therefore, central to our thinking about smoking and health"
(Philip Morris 1985).

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The importance of prices for the tobacco

industry
Cigarette Company Marketing Expenditures, by Type
United States, 1975-2008

Source: Chaloupka for an upcoming WHO publication

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Overview
Tobacco taxes, prices and demand
Relation between tax and price
Responsiveness of demand to tax/price changes

Impact on government revenues

Tobacco and poverty

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Tobacco taxes/prices and

demand

Why economists care about tobacco

taxes
Tobacco is NOT like most other products
Addictive
Very harmful to users and to others in society

Tobacco IS like other products

Its demand responds to
price changes relative to the price of other products
real income changes
changes in tastes and preferences

We can apply the lessons of economics to reduce its use

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Few close substitutes

About 75% of tobacco leaves grown globally are used for
cigarettes
Relatively small variety of tobacco products
Smoked: Cigarettes, Roll Your Own (RYO), Kreteks (clove
cigarettes), bidis, cigars, pipes, waterpies
Smokeless: Chewing tobacco (incl. Guthka), snuff (incl. Swedish
snus)

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Taxes and prices

An effective tax increase should increase prices of
tobacco products and make them less affordable
Tobacco industry is an oligopoly (large number of
consumers and small number of producers)
Industry tends to fully shift the tax increase to consumers rather
than absorbing it,
Often, we can see cases of overshifting (when the industry
ends up increasing the price by more than the consequence of
the tax increase to augment its profit margin),
This is more the case in jurisdictions with specific excise taxes

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Taxes, prices and demand

Increases in taxes that increase prices above inflation,
will:

Encourage some tobacco users to quit

Make some reduce their consumption
Prevent some formers users from starting again
Prevent some potential new users from taking up the
habit
When cheaper substitutable tobacco products/brands are
available, encourage some to substitute their
consumption to those products/brands

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Prices, demand and lung cancer deaths

Cigarette Prices, Cigarette Consumption, and Male Lung Cancer Deaths
France, 1980-2005
6.0
Numbe r
cigare tte s/adult/day

Number/adult/day

5.0

300

Lung Cance r De aths:

male s age 35-44/4

250

4.5
200
4.0
3.5

150
Re lativ e Price

3.0
100
2.5
2.0

50
1980

Source: Jha, 2009

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1985

1990

1995
Year

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2000

2005

Price/Deaths (% Relative to 1980)

5.5

29
27
25
23
21
19
17
15

200

GBP

180
160
140
120
100
2003

2004

2005

2006

2007

2008

2009

Real excise tax yield (GBP per 1000 cigarettes)

Smoking prevalence, males
Source: Excise tax yield: EU TAXUD; Prevalence: Cancer Research UK

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Tobacco taxes and prevalence

UK example

Prices and Consumption

Law of demand: all other factors held constant, the
quantity demanded of a product falls as price rises
Higher taxes reduce tobacco consumption
By how much?

The Price elasticity of demand measures how much

demand would change following a price change:
% change in the number of cigarettes consumed that results
from a one-percent increase in (the inflation adjusted) price of
cigarettes.

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Price elasticity of demand

Formula:

Q / Q Q2 Q1 P1
=

p / P
P2 P1 Q1
Sign: <0 because as P, Q (and vice versa)
For e.g. a price elasticity of -0.4 indicates that as prices
increase by 10%, demand will go down by 4%

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Relatively inelastic demand

Demand theory applies to tobacco products as well and
consumption goes down when price increases
but because of addictive nature of tobacco products,
tobacco demand is not very sensitive to price changes
price elasticity is between 0 and -1 (its absolute value
is smaller than 1) as % consumption < % price
but as time goes by people adjust to a price change
and are expected to reduce their consumption further
In the long run, price elasticity is estimated to be higher (more
sensitivity) than in the short run
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Price elasticity
Total (own) price elasticity - the effect of cigarette price
increase on the total amount of cigarettes bought
Combines
Effect of higher price on prevalence: how many
smokers stop smoking?
Effect on amount smoked by remaining smokers: how
many less packs per day

Demand will also be affected by changes in prices of

alternative products such as fine cut tobacco for roll your
own or pipes, or cigars or bidis etc
Cross price elasticity

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Price elasticity estimates

Estimates of price elasticites of cigarette demand in
high-income ~ -0.4
For low and middle income countries, most estimates lie
between -0.2 and -0.8
Effect of price:
Half is on smoking prevalence
Half on the intensity of smoking (quantity consumed)

(estimates of prevalence among adults)

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Price elasticity
data sources
Price elasticities can be calculated from two types of data sources:
Aggregate data (time series)
Easy and not costly to collect
But cannot tell why consumption went down (reduction in smokers or reduction
in quantity smoked?)
Fail to provide insight in variations in age, sex, income and education
distribution in tobacco users
Looks only at the impact of change in prices on legal sales
Survey (individual and household level) data:
Can separate the impact on consumption trough reduction in prevalence or
quantity used and measure reaction by socio economic status
Can capture total consumption (legal and illegal sales) and therefore the impact
of price changes on overall consumption
But are more costly and complicated to collect
And can suffer from reporting biases (people underreporting their consumption)
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Price elasticity estimates

Estimates from countries in the EU:

United Kingdom: -0.41 to -0.48 (2006, aggregate data)

Sweden: -0.81 (2004, long-run, aggregate)
Netherlands: -0.45 to -1.03 (2000)
Italy: (2009, aggregate)
-0.09 to -0.34 (short run)
-0.31 to -1.07 (long run)
Estonia: -0.34 (2004, survey data)
Poland: -0.4 (short run), -0.7 (long run) (2004, survey data)

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Price elasticity among the youth and

the poor
Youth are more responsive to price increases
Most estimates lie between -0.5 and -1.2 in high-income
countries
Two to three times the estimates for adults

Tobacco use is inversely related to indicators of socioeconomic status

Responsiveness to price increases higher among the poor than
the rich in high-income countries
Less evident in other countries maybe due to extent of
opportunity for tax avoidance and evasion

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Example
Total consumption of cigarettes Q1 = 100,000 packs (20 cig)
Price (P1) = 6 Eur / pack

Specific tax (t1) = 3.5 Eur

Tax increase of 1.5 Eur => t2 = 5 Eur

Tax fully passed on to consumer P2 = 6+1.5 = 7.5 Eur
Market impact: consumption goes down to Q2 = 87,000 packs
Price elasticity:
6
Q2 Q1 P1 100,000 87,000
=

= 0.52
7.5 6
100,000
P2 P1 Q1

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Income elasticity
Evidence suggests that income growth has also an
influence on consumption (affordability)
Most estimates of income-elasticity lie between 0 and 1
indicating that as income increases consumption will increase
to a certain extent.
Evidence of declining income elasticities in the USA

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Government revenues

Efficient revenue generation

Historically, the primary motive - still true in many
countries today
Tobacco taxes are a very efficient source of
revenue given:
Low share of tax in price in most countries
Relatively inelastic demand for tobacco products

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Efficient revenue generation:

Relatively inelastic demand
Taxes increase prices, reduce demand
But if demand falls by more than the increase in price, tax
revenues will decline
Relatively inelastic demand (e.g. -0.4) implies revenues
actually rise.
A tax-induced increase in price
Reduces consumption : Win for public health
But reduces consumption by less than 10 percent:
Win for tax revenues, certainly in the short and medium terms

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Example
Q2 = 87,000 packs; P2 = 7.5 Eur; t2 = 5 Eur
Price-elasticity = -0.52
Tax increase to t3 = 6.5 leads to P3 = 9 => price increase = 20%
The impact on consumption:
Price-elasticity x price change = -0.52 x 20% = -10.4%
Q3 = Q2 (10.4% x Q2 )= 77,952 packs

Revenue impact:
R2 = Q2 x t2 = 87,000 x 5 = 435,000 Eur
R3 = Q3 x t3 = 77,952 x 6.5 = 506,688 Eur
Revenue increase of 16% despite a decrease in consumption of 10.4%

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Tobacco and poverty

Tobacco Taxes and the Poor

Regressive tax: A tax that takes a larger percentage of
the income of low income groups than higher income
groups.
Share of income spent on tobacco generally falls as
income rises
Implies tobacco taxes are regressive in that tax burden is greater on
lower income

Prevalence of tobacco use is higher among the poor

Health burden of tobacco use also falls more heavily on lower income
persons
Tobacco use contributes to poverty
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But poor are more sensitive to price

changes

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Higher price sensitivity among poor

Evidence from Turkey in 2003
Price Elasticity (sensitivity) in 2003 by
expenditure group
Expenditure
groups

Elasticity of
smoking
participation

Conditional
Demand
elasticity

Total
price
elasticity

The poorest

-0,51

-0,60

-1,10

Poor

-0,41

-0,58

-0,99

Middle

-0,39

-0,46

-0,85

Upper Middle

-0,41

-0,36

-0,77

Rich

-0,45

-0,37

-0,82

Total

-0,40

-0,47

-0,87

Total price elasticity -0.87

A 10% increase in tax would

reduce consumption by 8.7%.
Within this reduction

Source: Onder & Yurekli 2006

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4% would quit smoking

Consumption would go down by
4.7%

Tax increases may be progressive

Lower SES populations are more price responsive
Tax increases
higher reductions among low SES where prevalence is highest
Higher impact in terms of life saving because mortality higher
among low SES
Implies tax increases may be progressive

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Higher taxes are Pro-Poor Policy

Higher taxes lead to higher

revenues which enables
governments to allocate more tax
revenues for social programs and
health systems. This is a Pro-Poor
Policy

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Bottom line
Cigarette tax increases will NOT negatively impact on the lowest
income populations
BECAUSE
Poor smokers bear disproportionate share of health
consequences from smoking and are more responsive to price
increases
Policy makers should consider progressivity or regressivity of
overall fiscal system
Negative impact can be offset by the use of new/extra revenue to
support programs targeting vulnerable populations or protect
funding for existing programs

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Conclusions
There is a strong justification for taxing tobacco for the
country's benefit (public health and economy):
Tax increases raise prices in the tobacco sector
Price increases reduce consumption and improve health
And at the same time increases revenues

Price elasticity is an important instrument to measure

the impact of tax/price increases on consumption
The young and the poor have a higher price elasticity

Taxes are regressive but tax increases can be

progressive
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