The price elasticity of demand for cigarettes in the UK

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The price elasticity of demand for cigarettes
in the UK
Tessa LangleyLecturer University of Nottingham

Howard ReedDirectorLandman Economics
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Background

• Increases in retail price recognised as
  effective strategy for reducing demand for
  tobacco
• Increasing price through increases in tax key
  component of government policy
• Policymakers need accurate estimates of extent
  to which demand for tobacco is affected by price

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Price elasticity of demand

• Key measure of effectiveness of increasing price
  to reduce consumption
• Measures change in consumption in response to
  price change
• If elasticity is between 0 and -1, commodity is
  inelastic
• If elasticity is lt -1, commodity is elastic
• i.e. The lower the absolute value, the higher
  the elasticity

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Elasticity examples

• If price elasticity -0.4
• 10 increase in price of tobacco
• ? 4 decrease in demand for tobacco
• If price elasticity -0.9
• 10 increase in price of tobacco
• 9 decrease in demand for tobacco
• Note ? in consumption ? ? in prevalence

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Elasticity and tax revenue

• Elasticity also affects revenue yield from
  increases in taxation
• The lower the elasticity of demand, the higher
  the revenue from increases in tobacco taxation
• Volume of cigarettes decreases by less in
  response to price increases

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Price elasticity of demand in the UK

• A frequently cited paper Townsend et al. 1994
• Survey data
• -0.5 for men, -0.6 for women
• Recent study Czubek Johal (HMRC) 2011
• Time series analysis of expenditure of UKDP
  cigarettes duty-paid cigarettes and tobacco
  industry price data
• 1982-2009
• -0.92 to -1.17
• No formal test of stability of results over time
• No controls for illicit or cross-border markets
• No statistical confidence intervals

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• AIM
• Use Czubek/Johal model (and data) to conduct
  detailed study of impact of price changes.
• OBJECTIVES
• Obtain up to date elasticity estimate
• Include data on other parts of market, esp.
  Illicit market, EU cigarette price data
• CI using bootstrapping

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Research realities...

• Unable to use Czubek/Johal data
• Tobacco industry refused use of price data
• But obtained data up to 2012
• Illicit market data only available from 2000
• No estimates over time
• Cross-border price data not suitable

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Data

• Consumption Data
• Monthly data on UKDP sticks cleared for
  consumption
• Jan 1991 Dec 2012
• Dummy variables to adjust for stockpiling ahead
  of tax increase in Budget

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Data

• Price data
• Weighted average price
• Clearances duty receipts

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Data

• Other explanatory variables (among others)
• Consumption of HRT
• Duty rate on HRT (proxy for price)
• Size of illicit market for HRT and cigarettes
  (since 2001)

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Statistical methods

• Cointegration modelling of data series in levels
• Two-step Engle-Granger approach
• Confidence intervals estimated using sieve
  bootstrap procedure

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Results
Time span 1991-2012 2001-2012 2001-2012
Illicit market variables? No No Yes
Elasticity -0.35 -0.78 -0.78
95 CI -0.51 to 0.02 -2.56 to 2.24 -2.58 to 2.25
90 CI -0.44 to -0.05 -2.00 to 1.40 -2.01 to 1.41

• Using entire time range (1991-2012), elasticity
  estimate of -0.35
• Significant at 10 level (not 5 level)
• Estimates on 2001-12 data not significant
• Adding illicit market variables makes no
  difference to estimated elasticity

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Discussion

• Price appears to influence consumption of UKDP
  cigarettes, but limited power (CI wider than for
  OLS)
• Limitations
• Volatile data due to inaccessible industry data
• No illicit market data pre-2000
• Uncertainty in estimates

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Discussion

• Builds on Czubek Johal paper
• Controls for illicit market
• Data up to 2012
• Results in line with existing UK and
  international estimates
• Increasing price should continue to be key part
  of UK tobacco control policy

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Conclusions

• Price continues to be an effective tool in
  reducing tobacco consumption
• Further research needed
• More accurate estimates
• Prevalence elasticity
• Elasticity of HRT
• Price segmentation

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References

• Townsend J. Price and consumption of tobacco.
  British Medical Bulletin 1996 52(1) 132-42.
• Czubek, M and Johal, S (2010), Econometric
  Analysis of Cigarette Consumption in the UK,
  HMRC Working Paper No 9, http//www.hmrc.gov.uk/re
  search/cig-consumption-uk.pdf

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Funded by Cancer Research UKs Tobacco Advisory
Group
Acknowledgements Deborah Arnott, Action on
Smoking and Health Thanos Alifantis and
colleagues, HMRC