The Law of Diminishing Return

The article “The Diminishing Returns to Tobacco Legislation” by Pierre Lemieux ( The Laissez Faire City Times , March 19, 2001) discusses the law of diminishing returns in relation to the consumption of tobacco products by government intervention in the cigarette industry.

The article makes some interesting and valid observations. Government intervention is required to reduce consumption of tobacco products. From 1985 to 1995, the consumption of cigarettes is reduced by 18 percent by raising taxes to 52 percent. From 1995 to 1999, prices jumped by 48 percent but consumption was reduced by 11 percent. The taxation on the tobacco industry has reduced the use of cigarettes. The government also decided to use a different strategy to reduce consumption. The Canadian federal government passed regulation to put large panic pictures of diseased lungs, hearts, gums etc. on cigarette boxes. By making people aware of the health risks associated with smoking, the government tried to persuade those smokers who were not persuaded by the tax increases.

Lemieux also points out that government intervention becomes less effective and resistance will develop. People who can be easily persuaded have already quit with initial intervention. It will take a lot more effort to persuade the remaining consumers and some may not be persuaded at all. The author also states that too much information may also kill information. With information saturation, people will start to ignore the warning messages. Consumers are aware of the health risks of smoking from independent sources which are highlighted by the images on cigarette packs.

The law of diminishing returns does not seem to have been reached.  The tax increase of 5.2 percent per year has reduced consumption by 1.8 percent per year over 10 years.  The tax increase of 4.8 percent per year has reduced consumption by 2.75 percent over a period of four years. As the law of diminishing returns has not yet been reached yet, the government has decided to use panic pictures on the cigarette packs.

Governments discovered a long time ago that tobacco products have inelastic demand. Although raising taxes, called Sin Taxes, will increase tax revenue due to inelastic demand, people will still buy nearly the same amount of cigarettes. Governments will neither make tobacco illegal nor create a public utility as proposed by David Kessler, former head of the U.S, Food and Drug Administration (Lemieux). By making tobacco sales illegal, governments will lose the tax revenue from tobacco sales and will face the task of controlling a black market of tobacco products.

Source: 

Lemieux, Pierre. “The Diminishing Returns to Tobacco Legislation.”  

Retrieved on Oct 10, 2012 from

http://www.pierrelemieux.org/artdiminish.html

Income and Cross Elasticity

Chart 1

Canada has the second largest crude oil reserve, most of it in Alberta. It is also the third largest producer of gas in the world. As the economy grows, the demand for energy resources, such as oil and gas, increases. The oil and gas industry has the largest share i.e. 54% of the economy in Alberta as chart 1 illustrates.

The state of the industry is improving, even though there is lot of noise about the environmental impact. More money is invested in development and production as long as the price of oil stays reasonably high and the projects remains feasible.

The measurable elasticity of oil and gas demand is inelastic in the short run but elastic in the long run. In the short run, oil and gas become necessities of life and not many substitutes are available. But in the long run, the other technologies like propane, electric and hybrid cars need to be developed to reduce the reliance on oil. Gas-powered power stations needs to be powered with other energy resources or should be converted to wind power or hydro-electric if possible.

Sources:

 “Demand for Canadian heavy crude is soaring”

                Retrieved on Oct 06, 2012 from

http://www.albertaoilmagazine.com/2011/11/demand-for-canadian-heavy-crude-is-soaring

 “ Importance of Oil and Gas Investment in Alberta”

                Retrieved on Oct 06, 2012 from

http://www.finance.alberta.ca/aboutalberta/spotlights/2011-0708-importance-of-oil-and-gas-investment-in-Alberta.pdf

Elasticity and Revenue

The advent of 3D TV is showing the same trends as HD-TV in terms of demand and pricing patterns. The price range of 3D-TVs is between $1300 and $6000+ depending on the size of screen and other features associated with it. Analysts are predicting the revenue growth of 3D-TVs from US $13.2 billion to US $67 billion worldwide and shipments of 3D-TV’s set to rise from 50.8 million to 226 million by 2019.



The price elasticity of demand is used to see how consumer demand is sensitive to price change assuming ceteris paribus (other things being equal). Consumer demand is extremely sensitive to higher price elasticity, whereas lower price elasticity results in a consumer demand with low sensitivity. The price elasticity of demand is the ratio of percentage change in consumer demand to the percentage change in price. The average value of price and quantity is used to calculate the change in percentage instead of lower or higher value. High price elasticity results in consumers buying less. Consumers buy more when price elasticity is at a low level. 

If we assume, the determinants of demand are ceteris paribus then the consumer demand for 3D-TVs will be sensitive to price changes. In a recent article, Mike Wheatley states that “auto-stereoscopic 3D, which is widely used on games consoles such as the Nintendo 3DS and does not require glasses, is some years away from becoming a reality in televisions due to the technology’s limitations in larger display sizes”. With the advancement of production techniques and advances in technology, the price of 3D-TVs will come down. Consequently, more people will buy 3d-TVs and sales will increase. In conclusion, the price elasticity of demand is elastic at higher price points and becomes inelastic at lower price ranges. The trends in graphs 1 and 2 make it evident that when prices are elastic, total revenue rises. When prices are inelastic, total revenue falls.

The following data illustrates the relationship between price elasticity of demand and total revenue.



The modified data is selected to show the points of elastic, unitary, and inelastic demand, although the data may not be as smooth as in the real world.



Graph 1



Graph 2

Source:

“3D TV Predicted To Spur 3-D Revenue Growth”

Retrieved on Oct 11, 2012 from

http://www.hdtvtest.co.uk/news/3d-tv-revenue-growth-201210012242.htm