Tuesday, 25 September 2018

Alcohol minimum pricing vs. taxes

Let's say that there was some good, where the government thought the market provided too much. Consumers consume too much of this product, compared to some socially efficient level. Economists call this a demerit good. The government might want to find some way of reducing consumption of the good. A tax seems like an obvious solution, and has the bonus effect of increasing government revenue - a double win!

But now let's consider a specific demerit good - alcohol. If the government taxes alcohol, the effects on the market are shown in the diagram below. The price that the consumers pay increases from P0 to PC, and the effective price that the producers receive (after paying the tax to the government) falls to PP. The quantity traded (and consumed) decreases from Q0 to Q1. Notice that the demand curve is quite steep (inelastic), so the tax doesn't reduce consumption by much. Notice also that, because the demand curve is steeper (more inelastic) than the supply curve, the price consumers pay goes up by a lot, while the effective price that producers receive falls by only a little. That means that consumers end up facing the burden of the tax. But, at least, the tax has reduced alcohol consumption, which was the aim.

But will the tax really reduce alcohol consumption? Maybe consumers notice the higher prices and simply switch from higher quality (and more expensive) alcohol to lower quality (and less expensive) alcohol. Then, they could continue to drink the same amount as before (but they would just be drinking lower quality beverages). This argument has been made by Eric Crampton (see here, for example).

If the government is concerned about consumers switching to lower quality alcohol, an alternative is to introduce minimum pricing (which I have discussed before, here). Indeed, that is what Northern Territory is about to do, as John Boffa noted in The Conversation this week:
From October 1, 2018, one standard drink in the Northern Territory will cost a minimum of A$1.30. This is known as floor price, which is used to calculate the minimum cost at which a product can be sold, depending on how many standard drinks the product contains...
 The implementation of the minimum floor price is the result of legislation, recently passed to minimise alcohol-related harms in the NT. From October, the NT will become one of the first places in the world to introduce a minimum price for alcohol.
What effect would minimum pricing have on the market? Here's what I wrote back in 2016 on the same topic (but I've updated the diagram to match the diagram above):
The effect is shown in the diagram below. Without minimum pricing, the market equilibrium price is P0, and the quantity of alcohol sold (and presumably consumed) is Q0. But with a binding minimum price (above the equilibrium price) of PC, the quantity of alcohol demanded falls to Q1. In other words, alcohol consumption falls.
Notice that the effect is to reduce alcohol consumption, which is what the government wants. Eyeballing the data in Boffa's article, it definitely shows an increase in price, and it seems that there is the decrease in quantity sold, but the decrease might not be statistically significant. Although Boffa notes:
As expected, the ban on cheap cask and fortified wine led some drinkers to turn to other types of alcohol. But while there was a 70% increase in the consumption of more expensive full-strength beer, the decline in the consumption of cheap alcohol more than offset this. This led to the overall 20% decline in consumption.
An added benefit of minimum pricing is that consumers can't switch between categories to essentially minimise the effect of the policy on their drinking, since a minimum price has a greater effect on low-quality (and therefore cheaper) drinks.

Now let's consider another good that some people would like to see the government act to reduce consumption (although it is arguable whether it is a demerit good) - sugar. A tax on sugar-sweetened beverages (which I've previously discussed here) would have similar effects to the tax on alcohol described above (although whether demand for sugar-sweetened beverages is as inelastic as alcohol is a separate issue). It would even induce consumers to switch to lower quality drinks, as Eric Crampton has argued (see here and here, for example). So, if the anti-sugar brigade want to reduce sugar consumption, wouldn't it be better for them to argue for a minimum sugar price instead?

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