The Economics of Smoking

2.The impact of price on the demand for tobacco products Many researchers once viewed cigarette smoking and other addictive behaviors as irrational and therefore not suitable for conventional economic analysis ( Elster, 1979;Winston, 1980; Schelling, 1984b).They believed that the demand for cigarettes (and other addictive substances) did not follow the basic laws of economics, including perhaps the most fundamental law, that embodied in the downward-sloping demand curve.As the nowsubstantial body of economic research demonstrates, however, the demand for cigarettes clearly responds to changes in prices and other factors, as found in applications of both traditional models of demand and more recent studies that explicitly account for the addictive nature of smoking.Conceptually, economists use a relatively broad definition of price that includes not only the monetary price of purchasing a product, but also the time and other costs associated with using the product.Restrictions on smoking in public places and private work sites, for example, impose additional costs on smokers by forcing them outdoors to smoke, raising the time and discomfort associated with smoking, or by imposing fines for smoking in restricted areas.Similarly, limits on youth access to tobacco may raise the time and potential legal costs associated with smoking by minors, while new information on the health consequences of tobacco use can raise the perceived long-term costs of smoking.This section focuses on the effects of monetary price on demand, while section 5 below considers the effects of other aspects of full price.In addition to price, a variety of other factors can affect the demands for cigarettes and other tobacco products, including income, advertising and other promotional activities, and tastes.In the industrialized nations, the relationship between income and cigarette consumption has reversed.Early demand studies (for example, Ippolito, et al., 1979;Fujii, 1980) concluded that cigarette smoking was a normal good, with cigarette consumption rising as income rose.More recent studies, however, have found that cigarettes have become an inferior good, in that the likelihood of smoking declines as income rises (Wasserman, et al., 1991;Townsend et al., 1994).The effects of advertising and promotion on the demand for cigarettes have been the subject of numerous studies; these are reviewed in detail in section 4 below.Finally, nearly all econometric studies of cigarette demand use a variety of factors to control for tastes, including gender, race, education, marital status, employment status, and religiosity.Given the focus of this book on economics, the impact of these socio-demographic determinants of demand will not be reviewed. 4 This section begins with a review of conventional studies of the impact of money price on cigarette demand.This is followed by a discussion of economic models of addiction and their applications to cigarette demand.Implications for the effects of price on cigarette demand from the relatively new field of behavioral economics are then reviewed.The section closes with a short consideration of the relatively limited research on the effects of price on the demand for other tobacco products. Conventional studies of cigarette demandNumerous investigators have estimated the effects of price on cigarette demand using conventional models of demand that do not account for the addictive nature of cigarette smoking.Their studies have used diverse econometric and other statistical methods on Economics of Smoking -p. 5 data from numerous countries.Many used aggregate time-series data for a single geographical unit, while others employed pooled cross-sectional time series data; still others used individual level data taken from surveys.The price elasticity estimates for overall cigarette demand from recent studies fall within the relatively wide range from -0.14 to -1.23, but most fall in the narrower range from -0.3 to -0.5. Analysis of aggregate dataMany recent studies use aggregate data and appropriate econometric methods to examine the effects of price on cigarette demand, controlling for income, tobacco control policies, and a variety of socioeconomic and demographic factors.The exceptions ( Baltagi and Goel, 1987;Peterson et al., 1992) compared changes in cigarette consumption in states that had raised cigarette taxes to consumption in states where taxes had not changed.The estimated price elasticities from these quasi-experimental studies, in the range from -0.17 to -0.56, are consistent with those obtained from the econometric studies.Although there are numerous studies of the price-demand relationship in industrialized nations, until recently there were almost no estimates for developing countries.Warner (1990) argued that price responsiveness in less developed countries is likely to be greater than in more affluent countries, given the relatively low incomes and relatively low levels of cigarette consumption by smokers in the poorer countries.Findings from studies using data from Papua New Guinea (Chapman and Richardson, 1990), China (Mao, 1996;Xu, Hu and Keeler, 1998) South Africa (van der Merwe, 1998a), Zimbabwe (Maranvanyika, 1998), and Taiwan (Hsieh andHu, 1997) are consistent with this argument.Several difficulties are encountered in studies using time-series data.Particularly troubling are the high correlations among many of the key independent variables and price.Consequently, estimates of the impact of price and other factors on demand can be sensitive to the inclusion and exclusion of other variables.Including highly correlated variables can result in multicollinearity and unstable estimates for the parameters of interest.Excluding potentially important variables, however, can produce biased estimates of the impact of price on demand.Recent studies using state-of-the-art econometric methods have addressed many of these difficulties ( Seldon and Boyd, 1991;