MAE101-Economic Principles

Question 1: The legal Australian cigarette market

In 2017 in Australia, 309 million packs of 25 cigarettes per pack were sold by Australian retailers, at an average price of $31 per pack. 

a)Illustrate the Australian legal cigarette market using a demand and supply diagram. Place the above numbers on your diagram.

b)What assumptions have you made about the elasticity of demand and supply?

c)Explain with the aid of a diagram the likely impact of an education programme to discourage cigarette smoking on equilibrium price and quantity.

d)Each cigarette that is manufactured in, or imported into Australia is subject to an excise tax. Using a diagram, (i) show the impact of the tax on the equilibrium price and quantity and (ii) discuss how the burden of the tax is likely to be shared.

Question 2: The market structure of the legal Australian cigarette market

The supply side of the Australian cigarette industry is probably best described as an oligopoly.  In January 2019, there were 60 brands of factory made cigarettes available on the Australian market, and across these brands, 327 pack size combinations were offered. The main cigarette manufacturers are: (i) British American Tobacco Australia; (ii) Phillip Morris Ltd.; (iii) Imperial Brands, and (iv) Others. Their respective market shares in 2017 were: 38.2%; 28.1%; 30.4% and 3.3%.

a)Why are firms in an oligopoly reluctant to compete on price?

b)How would you characterise the basis of competition in the cigarette industry?

c)In the case of an explicitly or implicitly colluding group of oligopolists, the correct diagram to use is that for a monopolist. Use the monopoly diagram to illustrate the likely price and quantity. You do not need to include any numbers on your diagram.

d) (i) Would we expect this outcome to be socially efficient? (ii) Explain why or why not.

Question 3: The illegal Australian cigarette market

This question is based on the article: “Fighting the ‘Up in Smoke’ gangs,” John Silvester. The Age. Saturday, December 16, 2017. Page 38.

You will find this article reproduced in the assignment folder.

The article vividly chronicles the mechanics of the market for illegal cigarettes in Australia. In topic 2c we studied taxes as a means of reducing consumption and generating government revenue. In topic 5a, we will study the use of taxes to tackle negative externalities. In this assignment, we will ignore negative externality issues associated with smoking, for example the fact that tobacco consumption places a high burden on the health care system.

a)(i) Draw the demand and supply curve for the illegal cigarette market in Australia. (ii) What assumptions have you made about the demand and supply elasticities in the illegal market when compared with the legal market?

b)Using separate diagrams showing the legal and illegal cigarette market, illustrate how an increase in the supply of illegal cigarettes is likely to impact both markets.

c)Many well intended government policies have unintended consequences, and it is the task of the economist to identify these. Give two examples identified in the article.

d)Illegally importing cigarettes is an example of a financial crime. Economists argue that unlike crimes of passion for example, the decision to participate in financial crime can be explained using the theory of rational choice, i.e. by comparing expected benefits and costs. Apply this reasoning to the importation decision, and in so doing, formulate a basic ‘rational’ decision rule. (Roughly 200 words).