How The Korean Government Can Impose Indirect Taxation On Cigarettes
Cigarettes are a demerit good that creates negative spill-over effects like ‘premature deaths’ and ‘financial issues’. The market for cigarettes is an example of market failure because resources are put into producing cigarettes instead of products with positive externalities to the society. (Allocative inefficiency)
Negative consumption of cigarettes
Cigarette consumption places the MSB curve below MPB curve. The vertical difference between MPB and MSB curve represents the external costs. The welfare loss shown in blue comes from the negative externalities caused by consuming cigarettes and represents the reduction in benefits for society as Qopt is lower than Qm due to over-allocation of resources to the production of cigarettes. If the welfare loss is corrected then society will regain this benefit.
Imposing indirect taxation on cigarettes by the Korean government
The Korean government intervenes by imposing indirect taxation. This will decrease the supply of cigarettes, MPC curve will shift inwards to MPC + tax. If the amount of tax imposed equals the size of external cost then the market equilibrium will return to the social optimum level of output (from A to B) and consumers will be paying a higher price (Paftertax). This allows allocative efficiency to be achieved again (MPB = MSB) and society will…