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China abolishes tobacco price

controls
 AFP
 JAN. 5, 2015, 1:08 AM

Beijing (AFP) - China has abolished price controls on tobacco leaf, the
last agricultural product to have limits, the country's top economic
planner said as authorities seek to give the market a greater economic
role.
But tobacco leaf prices are only a small factor in the cost of cigarettes -- a
state monopoly in China -- so the move is unlikely to have a significant
effect on smokers.
China is the world's biggest cigarette market and government efforts to
curb smoking have only had limited impact.
Tobacco was among 24 commodities and services whose cost controls
were removed, the National Development and Reform Commission
(NDRC) said at the weekend, with others including railway bulk cargo,
parcels, passenger transport and explosives for civilian use.
The move comes more than a year after Communist Party leaders
pledged to give the market a "decisive" role in resource allocation at a
key meeting known as the Third Plenum.
China's economy stagnated under decades of state control, but reforms
brought in starting under Deng Xiaoping have seen it enjoy an
unprecedented boom.
State-owned China Tobacco Company retains its monopoly on cigarette
production but the tobacco price will be determined according to
"industrial supply and demand and company costs and profits", the
NDRC said in a statement.
China produces about 2.5 million tonnes of tobacco a year, the state-run
China Daily quoted NDRC official Wang Shengmin as saying on Monday.
"Leaf tobacco only accounts for a very small portion of China's
agricultural market, and the relaxation won't cause much fluctuation of
cigarette prices, as the cost of tobacco leaves usually accounts for about 5
to 10 percent of the final product," he said.
Beijing city authorities have passed anti-smoking legislation set to take
effect in June as the government seeks to curb the habit among the
country's 300 million smokers.
But experts point to the state monopoly on cigarettes, which accounts for
nearly a tenth of national government revenue, as one of the biggest
obstacles to anti-smoking efforts.
Tobacco kills more than a million people each year in China, where some
brands can be purchased for as little as three yuan ($0.49). Chinese and
foreign experts say the number of smoking deaths could triple by 2030

Read more: http://www.businessinsider.com/afp-china-abolishes-tobacco-price-controls-


2015-1#ixzz3TLdFssfz
This article tells us about how China has abolished its minimum price
control on the tobacco leaf. In minimum price control, the government sets
the minimum price of the product above the equilibrium price .

Excess supply
Supply curve

Pmin

Price of P1
the tobacco

Demand curve

Q1
Quantity of tobacco demanded and supplied

The equilibrium price of tobacco is P1. But the government imposes a


minimum price control where prices of the commodity cannot fall below
Pmin. This price control leads to excess supply. The government purchases
this excess and stores it in warehouses or export them to other countries or
could even destroy the excess supply of tobacco. However storage tends to
be rather expensive and destroying products is considered a waste of
resources. Exporting often causes angry reactions from foreign
governments who claim that the tobacco is being dumped into their
market.1

Abolishing the price control would reduce the price of tobacco leaves to the
equilibrium price. This would lead to the decrease in the cost of production
for cigarettes which would in turn increase the demand for cigarettes as
price of the product is negatively related to its demand. But since the “cost
of tobacco leaves usually accounts for about 5-10% of the final product” the
reduction in the price of cigarettes would not be drastic. Furthermore, the
demand for cigarettes is relatively inelastic (PED <1) as smoking is an
addiction and a big change in the price of cigarettes would lead to a
proportionally smaller change to the quantity demanded. Price elasticity of
demand is the responsiveness or sensitivity of change in demand with
change in price. 2

Cigarettes produce negative externalities of consumption which in turn


causes market failure. Negative externality is an unintentional or indirect
negative impact on the third party.3 People who smoke enjoy some private
benefits of smoking4 and ignore the negative externalities they are creating
such as passive smoking which could lead to non-smokers suffering from
lung cancer, asthma, bronchial illness, etc. By ignoring the negative
externalities of consumption, these smokers are over-consuming cigarettes
and so there is a welfare loss to society. In order to reduce the consumption,
the government could impose indirect taxes on cigarettes, negative
publicity or could even ban cigarette smoking totally.

1 IB Diploma Programme Economics Course Companion, Page 73 – last paragraph.


2
Economics Class Notes
3 Economics Class Notes
4
IB Diploma Programme Economics Course Companion, Page 144 – last paragraph
Imposing of a higher rate of tax on cigarettes would be beneficial for the
government as they could obtain more revenue from it. Furthermore, more
taxes would mean that the price of cigarettes would rise and so decrease the
demand for it and help curb smoking in the ‘world’s biggest cigarette
market.’ Abolishing the price control would also enable the government to
use the money that was being spent on correcting the excess supply that the
price control caused. This money could be used to improve the welfare of
the country and fund other economic development projects.

Abolishing the price control would discourage farmers from planting


tobacco as the prices are no more set and so could fluctuate depending on
the demand and supply. Furthermore, since cigarettes is a state monopoly
in China, there are chances that the tobacco would not even be able to be
sold at the equilibrium price since there is only one market for it i.e. the
State-owned China Tobacco Company: The tobacco farmers would have to
sell their tobacco at whatever price the Tobacco Company states for lack of
another market. So by taking advantage of their monopoly, the government
would earn more profits but the poor farmers would incur losses. The
reluctance of farmers to plant tobacco would also reduce the supply while
the demand still remains the same. This would lead to a rise in the price of
the tobacco and a subsequent rise in the cost of production of cigarettes and
the final product. This would lead to a decrease in the number of cigarettes
demanded and so a reduction in the negative externality it causes and the
number of deaths that occur due to smoking.

The abolishment of the price control could even lead to better quality of
tobacco as it would discourage small scale farmers from planting tobacco
and enable only the large scale farmers to endure in this field. Before the
farmers could produce low-quality tobacco as the sales were assured and
the prices set. Government incentives had encouraged small-scale farmers
to grow tobacco even on the land where it can’t be grown. The better quality
of tobacco would also help in reducing the diseases that is caused due to
cigarettes.

Thus, these are the impacts that China would face on abolishing the price
control on tobacco leaves.

745 words.