Advertising Externalities- Cigarettes

Cigarettes are a demerit good which is a good that is over provided by the market and consumption of this good is harmful to society. Cigarettes are harmful to society because they produce a negative externality. This is because the consumption of cigarettes have a spillover effect on third parties and no compensation is paid by anyone. For cigarettes, the benefit of consuming has a greater effect on the consumer than on society. So the marginal benefit for the consumer is greater than it is on society. This results in an allocative inefficiency is achieved by the industry producing the cigarettes. This negative externality produced by cigarette consumption causes major health issues for the consumer and greater adverse effects for society. Before the government ban on advertising was set in 1970, this externality was much greater. Without the ban, the average price of cigarettes was lower which caused an increase in cigarette consumption, an increase in consumer surplus and a decrease in producer surplus. When the government was restriction was enacted, prices increased resulting in a negative change in total surplus. This meant that government intervention was successful in reducing the negative externality effect on society.

Below is a graph that shows how a ban on positive advertising and a tax on cigarettes was beneficial for society because it reduced the size of the negative externality.



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