ChainWhat it assumes · how to break it
Start
People smoke cigarettes near others, exposing them to second-hand smoke, and smoking-related illness is treated by the NHS at taxpayers' expense.
1
As a result, smoking imposes external costs on others, through harm from second-hand smoke and the cost of treating illness, so the marginal social benefit of smoking is below the smoker's marginal private benefit.
external cost · MPB · MSB
external cost · MPB · MSB
Assumes: Part of the cost falls on people other than the smoker.
But: Much of the harm, such as the smoker's own illness, falls on the smoker and is a private cost, so the external cost may be smaller than it appears.
2
Since smokers decide how much to smoke by weighing their own benefit against the price, they ignore the cost to others.
self-interest · consumer decision-making
self-interest · consumer decision-making
Assumes: Smokers take no account of effects on others.
But: Many smokers choose to smoke outside or away from children, and bans on smoking in enclosed public places limit the harm to others.
3
Therefore, consumption occurs at Q1 where MPB = MPC, beyond the social optimum Q* where MSB = MSC.
overconsumption
overconsumption
Assumes: No policy fully corrects the externality.
But: Tobacco duty and smoking bans already reduce consumption towards Q*.
4
This means on each cigarette between Q* and Q1 the marginal social cost is greater than the marginal social benefit, so these units reduce total welfare and create a deadweight welfare loss.
deadweight welfare loss · allocative inefficiency (MSC > MSB)
deadweight welfare loss · allocative inefficiency (MSC > MSB)
Best link to attack
Assumes: The smoker's private benefit is a true measure of the benefit to the smoker.
Assumes: The smoker's private benefit is a true measure of the benefit to the smoker.
But: Because nicotine is addictive, part of what smokers feel as benefit may be relief from withdrawal, so true MSB is lower still and the welfare loss is larger than the triangle shows.
End
Overconsumption of cigarettes causes a deadweight welfare loss: MSC exceeds MSB on every unit between Q* and Q1.
Evaluation chain
- E1However, the size of the welfare loss depends on whether smokers' private benefit reflects the benefit they really get.
- E2If addiction leads smokers to value cigarettes more highly than they would on reflection, the MPB curve overstates the true benefit.
- E3As a result, the true MSB curve lies further below MPB and the gap between MSC and MSB on each extra cigarette is wider.
- E4So the welfare loss is larger than the externality alone suggests, which is why cigarettes are also treated as a demerit good.
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Questions this answers
- Using a diagram, explain the welfare loss from a negative consumption externality.
- Explain why the market for cigarettes is allocatively inefficient.
- Evaluate the extent to which smoking reduces economic welfare.
Diagram
MPB above MSB, with MPC = MSC (supply): market output Q1 where MPB = MPC, social optimum Q* where MSB = MSC, so Q1 > Q*. Shade the welfare loss triangle between MSC and MSB from Q* to Q1, with its point at Q*.
Reverse and related
Positive consumption externality → underconsumption and a welfare loss on the units between Q1 and Q* that are not consumed.