Congratulations to my RMIT colleagues Lisa Farrell and Tim Fry for winning the Economic Papers Best Paper Prize for 2013 for a paper entitled, “Is Illicit Tobacco Demand Sensitive to Relative Price?” (ungated version here).
First thing to note:
This research was funded under the Australian Research Council Discovery Grant DP0662751.
Second – why is the research important?
Tax and excise rises serve to increase the price of licit relative to illicit tobacco. Consequently there has been a rise in black market tobacco consumption. This paper investigates the degree of substitution between licit and illicit tobacco using novel survey data.
Then some of the results and conclusions:
One also sees that a critical point in these results is where those who report they would decrease their consumption in the illicit market is exceeded by the number of smokers who say they would increase their consumption in the illicit market. This point occurs at a price ratio of 1:2.50 (switch point A). This point is below the current price ratio of 1:3 and suggests that further increases in the price ratio will serve to increase the consumption of illicit tobacco by current users.
In summary, this shows that further increases in the price ratio will lead to an increase in the demand for illicit tobacco from this group. From a policy perspective these findings are especially interesting. The current policy climate in Australian remains actively anti-smoking and further tax increases for the licit market have been announced since our survey. Indeed, the expected price rises in the formal sector will soon take us to switch point B (assuming that all other things remain constant). This has clear implications for the health and welfare of those individuals currently engaged in the illicit market.
What did they say about Plain Packaging?
An innovative Australian federal policy is the proposal to ban brand identity from cigarette packets. Given that the illicit market consists of essentially unbranded tobacco, this policy will blur the distinction in terms of the product differentiation between the two markets. Moreover, it was suggested by one of the major tobacco companies operating in Australia (British American Tobacco) that their response to this policy would be to halve the price of the legal tobacco that it sells. Such a response would create a direct impact on the price ratio. Our analysis shows that illicit tobacco consumers are relative price sensitive, even in a highly differentiated product market. Thus one would expect the removal of branding to increase the relative price sensitivity and lead to concerns about the overall benefit of such a policy.