Eventual oversupply
How does the tax affect supply and demand? How does the tax affect the equilibrium price and quantity? As to how the tax would affect the supply and demand may be seen in the change in the equilibrium price and quantity. A change in the equilibrium price and quantity caused by the increase in price if the tax is borne by producer will eventually result to shortage of the good in the market as fewer quantities are produced while quantity demanded remains the same.
On the other hand, a change in the equilibrium price and quantity caused by the increase in price if tax is borne by consumer will eventually result to oversupply of the goods in the market as less quantities are demanded while quantity produced remains the same. At this point, it is now possible to describe in this market a hypothetical situation where a price ceiling or floor could be imposed and to determine what implications would this have for the market.
Where a price ceiling for the sale of cigarette would be imposed by the government, the effect for the market would be as follows: Suppliers discover about their inability to maintain their old prices before the price ceiling and this would eventually cause them to get out the market or industry when the reduction of their quantity supplied will not assure them some profitability. The price ceiling would make consumers happier because they can they can now purchase the same product at a lower price compared when there was no price ceiling.
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This would therefore produce higher demand eventually and causing shortage of the goods in the market. Where a price floor is set for the same product, effect would be as follows: Consumers or demanders discover that they need to spend more for the same product. This would therefore cause them to reduce their purchases or withdraw from the market entirely. For the time being, suppliers discover that they assured of a higher price compared with that before the price floor and this would cause them to produce more until an oversupply would ensue.
It can be concluded that the effects of taxation of a good in the market could either create a shortage or oversupply of the same good depending on who bears the tax. Who bears the cost depends on the inelasticity of the supply and demand when the tax is imposed. If the producers bear the tax, the eventual result is shortage while if it is borne by the consumer it is oversupply. Research appears to show that it is the consumer who bears the tax.
As to the effect of price control on the economy, which may be done by government setting a price ceiling or a price floor, it may be concluded that the first would produce a shortage of the good while the second one would produce and eventual oversupply of the good.
References: Bourne, D. et. al (1994) The effect of raising state and federal tobacco taxes – tobacco consumption, Journal of Family Practice, {www document} URL, http://findarticles.com/p/articles/mi_m0689/is_n3_v38/ai_15168855, Accessed January 13, 2008 Liang and Chaloupka (2002), Differential effects of cigarette price on youth smoking intensity, Society for Research on Nicotine and Tobacco US Department of Health and Human Services. Smoking and Health in the Americas. A 1992 Report of the Surgeon General in collaboration with the Pan American Health Organization. Atlanta, Ga: Centers for Disease Control, Office on Smoking and Health, 1992; DHHS publication No. (CDC) 92-8419.
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