Price elasticity of demand

1. Price elasticity of demand PRESENTATION 3 Workshops on Tobacco prices and taxation World Health Organization (WHO) and International Union Against Tuberculosis and Lung Disease (The Union)

2. Part 1. Changes in tobacco consumption resulting from changes in tobacco prices Part 2. Changes in government revenues resulting from changes in tobacco prices

3. Part 1. Questions • What are the key determinants of tobacco consumption? • What is price elasticity? • What does a price elasticity of -0.4 mean? • Why do people continue to buy cigarettes even in countries where the price is as high as US$ 8.00 per pack? • What other factors can affect how strongly consumers respond to price increases?

4. increase? Revenue impact? Effect on deaths? Two important determinants of tobacco consumption are the price of tobacco products and household income. As real tobacco prices increase, there is a decrease in the consumption of tobacco... Or if tobacco prices decline relative to the cost of other goods and services, consumption increases.

5. As real tobacco prices increased in Morocco, consumption declined… Inflation Adjusted Cigarette Prices and Cigarette Consumption, Morocco, 1965-2000 Source: Aloui, 2003

6. Price Elasticity of Demand Why do smokers continue to smoke even in countries where the prices is very high – such as in Ireland where a pack of cigarettes could cost US $8.00? The quantity of cigarettes the consumers desire is not very responsive to changes in price… or demand is ‘inelastic’…

7. Price Elasticity • measures the strength of the relationships between price (P) and quantity demanded (Q) • % change in Quantity/% change in Price • is a function of the slope of the demand curve (the steeper the slope, less elastic the good)

8. If the price of cigarettes increased by 20%, and quantity decreased by 2%, what is price elasticity (PE)? PE = .1  inelastic < 1 = inelastic (price increases have less impact) 1 = unit elastic (1 unit to 1 unit impact) • >1 = elastic • (price increases have greater impact)

9. Other factors affecting demand • Availability of substitutes: Goods with more substitutes tend to be more elastic (consumers are very responsive to price) • Income: greater the income level, the less sensitive consumers are to changes in price. For example, the poor and youth are more price-sensitive (a 10% price increase reduces smoking as much as 10% among youth and the poor). • Time: In the short-run, cigarettes are inelastic, but if smoker quits gradually, cigarettes are more elastic over time

10. Estimates of price elasticity have ranged from -0.2 (Turkey) to -0.9(Bolivia), with median value of about -0.4 Asia Bangladesh -0.27 China -0.54 Indonesia -0.34 Nepal -0.8 Sri Lanka -0.53 Thailand -0.39  Eastern Europe Bulgaria -0. 80 Estonia -0.34 Turkey -0.19  Latin America Argentina -0. 27 Bolivia -0.85 Brazil -0.25 Chile -0.22 Uruguay -0.49  Middle East Egypt -0.40 Morocco -0.31 Sources: Adioetomo, Djutaharta, and Hendratno 2005; Alcaraz 2005; Ali, Rahman, and Rahman 2003; Aloui 2003; Arunatilake and Opatha 2003; Debrott Sanchez 2005; Gonzales-Rozada 2005; Hu and Mao 2002; Iglesias and Nicolau 2005; Karki, Pant, and Pande 2003; Nassar 2003; Onder 2002; Ramos and Curti 2005; Sayginsoy 2002; Taal 2004. These reports are available on line at http://www.worldbank.org and for Latin America at http://www.paho.org.

11. Part 1. Review • What are the key determinants of tobacco consumption? • What is price elasticity? • What does a price elasticity of -0.4 mean? • Why do people continue to buy cigarettes even in countries where the price is as high as US$ 8.00 per pack? • What other factors can affect how strongly consumers respond to price increases?

12. Part 2. Changes in government revenues resulting from changes in tobacco prices

13. Part 2. Questions • If people stop smoking in response to a tobacco tax increase, why do government revenues tend to increase? • What factors affect the revenue-generating potential of a tobacco tax increase?

14. Increases in tobacco taxes have the potential to generate increases in government revenues • As price rises, consumption falls, but by less than the percentage rise in price (demand is price-inelastic). • As incomes rise, so does consumption - and total revenue (the income elasticity of demand is greater than one).

15. The total amount of revenue that can be generated depends on several keys factors: • Tobacco Consumption level • Tobacco tax rates • Retail price of cigarettes • Household incomes • Control of smuggling activities

16. Governments tend to generate revenues from tobacco tax increases because the demand for tobacco is generally inelastic People do respond to changes in tobacco prices (particularly those that are price sensitive such as children, the poor, and infrequent smokers). However, most people continue to smoke despite increases in tax, although their consumption may decline (they smoke less cigarettes). The remaining smokers pay a higher tax – therefore government revenues tend to increase from a tobacco tax. This suggest that tobacco taxes are good instruments to achieve both revenue and public health goals.

17. Example from China: an increase in tax of RMB 1/pack (approx US$ 0.15) reduces the number of smokers by 13.7 million people and saves 3.4 million lives Teh-Weh Hu , Zhengzhong Mao, Jian Shi, Wendong Chen 2008.

18. However, the remaining number of smokers in China are 295.1 million people after the tax increase. Since the remaining smokers pay a higher price after the tax, there is an increase in government tax revenues from the tax increase. Teh-Weh Hu , Zhengzhong Mao, Jian Shi, Wendong Chen 2008.

19. Part 2. Review • If people stop smoking in response to a tobacco tax increase, why do government revenues tend to increase? • What factors affect the revenue-generating potential of a tobacco tax increase?

20. Group discussion Among the countries represented in this room, where are tobacco consumers -the most responsive to price? -the least responsive to price? Why do these differences exist among countries?