Economics of Smoking

What Is The Economics Of Smoking And Why Should One Care?

Economists divide markets into demand and supply. Demand reflects individual preferences, relative prices, income, and other factors. Supply differs according to market structure; prices depend on whether the market is competitive or not and the extent of government intervention in the market. On the demand side, decisions about whether or not to smoke are referred to as the extensive margin. Conditional on smoking, the frequency, and intensity of smoking refers to the intensive margin. The decision to smoke is particularly interesting given the addictive properties of cigarettes and the delayed consequences of smoking. Given such consequences, perceptions of risk of future adverse effects, and the discount rate applied to the future cost of smoking have a key role in decision-making. Additionally, government interventions prompt individuals to take externalities into account in their demand decisions.

On the supply side, much emphasis is placed on the cigarette industry’s advertising practices. Governments seek to offset such promotion by publicizing the adverse effects of smoking. In the USA, the Master Settlement Agreement (MSA) limits the industry’s ability to promote its products and the settlement has increased production costs in the USA which, coupled with substantial increases in excise taxes on cigarettes, has further increased cigarette prices.

The economics of smoking is worthy of attention for several reasons. First, smoking is among the most harmful behaviors to personal health and longevity. Considering the combined cost of internalities and externalities, the societal cost per pack of cigarettes was US$37 in 2004. The main internalities relate to adverse health effects to the smoker. This raises a question about why someone would engage in such behavior. Second, the topic raises issues of fundamental importance to economics, including whether or not people are rational in their decision-making, the accuracy of risk perceptions, preference heterogeneity (e.g. in risk and time preference), and the role of addiction in explaining consumption patterns over time. Third, from a public policy perspective, the track record includes some successes, but effects of many public policies are below initial expectations. Even after decades of policy intervention, in the USA more than 20% of adults continue to smoke. Fourth, even though the share of the US population that smokes has declined, in other countries, especially in lower-income countries, this share continues to increase.

This review will mainly focus on recent economic literature and focus on the USA, where most studies have been conducted. The authors do not discuss important research conducted outside economics.

The Section Alternative Frameworks provides an overview of theoretical frameworks by economists and direct empirical tests of the implications of these models. In the Section Direct Empirical Tests of the Alternative Frameworks, other empirical tests of these frameworks are turned to. In the Section Other Empirical Evidence to Explain Continued Smoking, the empirical evidence on continuing smoking is reviewed. Sections Price: Effect of Cigarette Taxes and Effects of Other Cigarette Demand Determinants review findings on price and other determinants of cigarette demand. In Sections Effects of Smoking on Longevity and Health and Other Effects of Smoking, the authors summarize empirical evidence on the consequences of smoking on health, wages, labor force participation, and expenditures on personal health care services. The Section Effects of Policy Interventions evaluates evidence on demand- and supply-side public policies that have the goal of reducing cigarette consumption.

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