This is a colour coded suggested answer to the May 2014 EdExcel economic question on the market for cigarettes. Colour coding is used to demonstrate the different skills of knowledge, application, analysis and evaluation to show how answers can be constructed to earn high marks under timed conditions.

1. AS Micro: Data Response Question on
Cigarettes / Aspects of Government
Intervention (EdExcel) May 2014

6. Knowledge Application
Analysis Evaluation

7. With reference to the information provided, explain two possible causes of the
decrease in tobacco smoking. (4 marks)
Figure 1 shows that the % of adults who smoke in Britain has declined from 45%
in 1974 to 20% in 2010. Extract 1 mentions that the fall in market demand may
have been the result of “government health campaigns warning people of its
dangers” along with tougher regulations such as banning sales from vending
machines together with higher indirect taxes on each pack of cigarettes with
taxes now 80% of the retail price.
Health campaigns have the effect of increasing the lowering the private benefit
of consumption, whilst higher taxes will cause the costs of cigarette
manufacturers to rise leading to an inward shift of supply and market
equilibrium prices to rise. This has the effect of reducing the real purchasing
power of cigarette smokers. Both factors will cause market demand to fall.
Knowledge Application
Analysis Evaluation

8. Outline the likely impact on consumer surplus and producer surplus in the tobacco market of a
decrease in demand for tobacco. Illustrate your answer with a supply and demand diagram (6)
Consumer surplus is the difference
between the price a consumer is willing
and able to pay and the market price
they actually pay.
Producer surplus is the difference
between the price a producer is willing
and able to supply their product and
the market price they receive. When
market demand for tobacco falls, there
is an inward shift of demand leading to
a lower price. The effect is that both
consumer and producer surplus will
fall. This is shown in my diagram.
Knowledge Application
Analysis Evaluation
Price
QuantityQ1
D2
S1
Q2
A fall in demand causes consumer
surplus to fall from area DEG to
ABF. Producer surplus falls from
area CDE to ABC
D1A
B
C
D
EF
G

9. Using the information in Extract2 and your own knowledge, discuss whether the demand
for tobacco products is likely to be price inelastic or price elastic (10)
Price elasticity of demand measures the responsiveness of demand
to a change in the good’s own price. When a price increase causes
total spending to rise, demand will be inelastic i.e. the coefficient of
PED < 1. For example a 20% rise in price might cause only a 5% fall in
demand giving a PED of -0.25. Extract 2 says that despite large price
rises, annual total expenditure on tobacco has increased by £200m
between 2010-2011. This is evidence that demand is price inelastic.
Ped is likely to be low because of strong habit-forming consumption
among cigarette users. And for many people who smoke only
occasionally, their spending is a relatively low percentage of income.
However Extract 2 tells us that tobacco consumption is higher
among lower-income groups whose spending will be a high % of
their budget and for whom demand might be more price sensitive.
This suggests that other factors might make demand for cigarettes
price inelastic such as social factors or due to people experiencing
information failures about the long-term dangers of smoking.
Knowledge Application
Analysis Evaluation
Price of Cigarettes
Qty of
Cigarettes
D1 D2
S1
P1
P2
S2
Q1Q2

10. With reference to the information provided and your own knowledge, discuss the likely
benefits to consumers and the government of a decrease in tobacco smoking. (14)
Data in Figure 2 is from Action on Smoking on Health which is an anti-smoking pressure
group. Figure 2 provides evidence on external costs from smoking. Smoking creates
negative externalities i.e. third party spillover costs for which no appropriate
compensation is offered. These externalities range from the extra spending in the NHS
when treating smokers (estimated at nearly £3bn per year), to the £300m needed for
local authorities to clean up smoking-related litter.
A fall in tobacco consumption will help to lower social costs and thus reduce the effects of
market failure. It can bring about an improvement in social welfare as shown in my
diagram. Smokers themselves will benefit from improved health and higher incomes if
they take fewer days off sick. There is also a high opportunity cost to heavy smoking, so if
demand falls, then smokers will have more disposable income to spend on other goods
and services or on their families.
We must also remember that many of the externalities of smoking affect non-smokers for
example the dangers of passive smoking – so the health of the families of smokers will
also improve over time. These are estimated by ASH to be £700m a year.
Knowledge Application
Analysis Evaluation

11. With reference to the information provided and your own knowledge, discuss the likely
benefits to consumers and the government of a decrease in tobacco smoking. (14)
Knowledge Application
Analysis Evaluation
Consumption of Cigarettes
Marginal
Private Cost
P1
Q1
Marginal
Private Benefit
Costs,
Benefits
£s
Marginal
Social Cost
Q2
P2 This is the area of
social welfare loss
because the market
equilibrium output is
higher than the social
optimum. The
consumption of de-
merit goods such as
cigarettes leads to
market failure

12. With reference to the information provided and your own knowledge, discuss the likely
benefits to consumers and the government of a decrease in tobacco smoking. (14)
From the government point of view, cigarettes are a big source of tax revenue. Extract 2 tells us
that the British government received £12.1bn in revenue from indirect taxes on tobacco in
2012 – this is an important tax given the challenge of cutting the budget deficit and reducing
the national debt. So a fall in smoking could cost the government money in the long-term and
they might have to find extra tax revenues from other areas such as a rise in VAT and higher
income taxes.
However we must also remember that cigarette smoking can have negative externalities for
the economy as a whole. Figure 2 estimates the annual value of lost national output (GDP)
from the early death of smokers at over $4bn a year and we can add to this the lost
productivity which might damage our competitiveness and exports. Another argument is that
reduced spending on cigarettes frees up disposable income to spend elsewhere so that the net
effect on consumer spending and AD will be small.
In the long run, a higher level of national output plus reduced tobacco-related spending in the
National Health Service is likely to be a net benefit for the government.
Overall I would argue that the social benefits from less spending on tobacco outweigh the
short term fiscal costs to the British government.
Knowledge Application
Analysis Evaluation

13. With reference to the information provided and your own knowledge, to what extent might
regulations on the sale of cigarettes and high taxes on tobacco result in government failure? (14)
In recent years, the UK government has introduced many regulations designed to cut sales
of cigarettes. Extract 3 mentions a ban on smoking in public places and we have also seen a
block on cigarettes being displayed in retail outlets, vending machines, the end of tobacco
advertising on television and tough penalties on retailers who sell cigarettes to under-age
consumers. New regulations will also make all cigarettes sold in plain packaging without
any branding in the near future.
Government failure occurs when an intervention leads to a deeper market failure or even
worse a new failure may arise. In other words – intervention in a market creates further
inefficiencies, a misallocation of resources and a loss of economic and social welfare.
Government failure can occur when a policy is ineffective in achieving set aims. For example
the 80% indirect tax (duty) on cigarettes may be a key factor leading to smuggling of
tobacco into the UK, much of which is of lower quality than sold legally. Not only does the
government lose out on much-needed tax revenue, but there are negative externalities
from people consuming higher-strength tobacco together with the information gap about
possible contamination of the product. Extract 3 tells us that plain packaging might lead to
this unintended consequence – a type of government failure.
Knowledge Application
Analysis Evaluation

14. With reference to the information provided and your own knowledge, to what extent might
regulations on the sale of cigarettes and high taxes on tobacco result in government failure? (14)
Many aspects of cigarette regulation can have unintended consequences. For example the ban
on smoking in public places led to a surge in the use of outdoor patio heaters by restaurants
and pubs. These create further external costs without causing a reduction in demand. The
smoking ban may also have been a factor behind the closure of many pubs in recent years
which has caused a loss of employment. To evaluate, other factors are likely to have been more
important in causing pub closures such as rising sales of cheap alcohol in supermarkets.
Indeed, it could be argued that fewer people smoking in restaurants has a beneficial effect as
non-smokers will be able to enjoy an evening eating and drinking without suffering the effects
of passive smoke.
Government failure can exist when interventions are simply not effective enough to change
the behaviour of consumers. It would appear that higher taxes have only had a limited effect
on smoking – Figure 1 reminds us that 20% of adults still smoke and Extract 2 says that 5% of
11-15 year olds inhale. To overcome government failure, more effective long-run policies need
to be considered. For example, behavioural nudges such as denying certain NHS treatments to
smokers unless they participate in a cessation programme might work better. Or perhaps
incentives such as cutting the VAT on nicotine patches. Smart, tested policies can help to
overcome the problems of government failure.
Knowledge Application
Analysis Evaluation

15. AS Micro: Data Response Question on
Cigarettes (EdExcel) May 2014