Australia’s an indirect tax which theoretically would cause the

Australia’s significant approach towards cigarette tax may not be working as the government have hoped it would. Tobacco is a demerit good, a good that is considered to be undesired for consumers, but is overprovided by the market. Demerit goods often have negative externalities of consumption, in which case there is an overallocation of resources to the production of the good. A negative externality of consumption is the external cost the consumption of a good creates for third parties. The overproduction of tobacco causes allocative inefficiency, hence tobacco consumption is an example of market failure. Market failure being when the market fails to allocate resources efficiently, due to too little or too much of a good or service being produced/consumed. Figure 1 shows the negative externality of consumption caused by consumption of cigarettes. The demand curve (MPB) represents the demand for cigarettes at any given price and does not reflect social benefits. When cigarettes are consumed they create negative effects for third parties, such as passive smoking and medical related illnesses. These can be seen as ‘negative benefits’ meaning that the Marginal Social Benefit (MSB) curve lies below the Marginal Private Benefit (MPB) curve. “Annual deaths from tobacco-related diseases, about 15,000 in recent years,” is proof of the effects this has on third parties, medical cost, funeral cost, often paid for by a third party, ie insurance.The Australian government has decided to implement an indirect tax which theoretically would cause the supply curve to shift upwards. A supply shift upwards means that for each quantity sold, the price is higher. Assuming that the tax was equal to the externality, the externality could be removed. In order to correct Market failure, allocative efficiency must be achieved. The quantity sold must move to Qso in order to achieve allocative efficiency as this is the socially optimal level.

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