Consumer Market Failure – The Economics of alcohol consumption
Year Group: Year 13
Subject: Economics
Topic Reference: Consumer Market failure and the economics of alcohol consumption
Time/Length: 2 hours
Aims:
1. Revise the concepts of market failure, externalities and demerit goods.
2. Illustrate the concepts of Price Elasticity of Demand (PED) and Cross Elasticity of Demand
(XED) and show how they can be used to influence government policy.
3. Allow students the internal and external costs and benefits of alcohol use.
4. Give students the opportunity to evaluate a range of policy options.
Learning outcomes:
At the end of the lesson the students should be able to:
1. Define the following terms: market failure; external costs; demerit goods; price elasticity of
demand and cross price elasticity of demand.
2. Explain the costs and benefits associated with alcohol misuse.
3. Explain the effect imposing an indirect tax will have on the market for alcohol.
4. Use the concepts of PED and XED to justify changes to the tax on alcohol.
5. Provide a coherent evaluation of a range of government policy measures designed to
reduce the problems associated with alcohol misuse.
Resources:
Use of the internet: http://www.edecon.ndo.co.uk/_notes/Drug%20use%20in%20uk%202.doc
www.bized.ac.uk/glossary/index.htm
Worksheet (included with lesson plan)
Lesson summary
Introduction:
This lesson can be done as a one-hour class, however I feel that it is better to give it as a group
homework assignment.
Giving the students one week to complete the assignment allows plenty of time for the group to
meet up outside of class time to work on the assignment together. This is especially important
for question 13.
1. Divide the class into 5 groups and distribute the worksheets.
2. Spend a few moments explaining what is required from each student. Students must work
together but each student must complete all of the tasks.
3. Give the students a deadline (1 week is about right) and explain that a prize will be given for
the best argument presented in question 13.
4. After 1 week go over the answers to questions1-12.
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5. Each group presents their argument for question 13 and a prize is given for the best
presentation.
Teacher reflection:
Although this can be used in class I would encourage teachers to do this as a group assignment
over 1 week. I have found that this helps to create a team spirit in the class and also provides
the opportunity for peer mentoring.
Giving a prize for the best presentation in question 13 also encourages a little competition in the
class. (As economists we are aware of the benefits of competition).
Assessment opportunity:
Explain why some people would consider hard drugs like cocaine and cannabis to be demerit
goods. (8)
The government has recently reclassified cannabis from a class B drug to a class C drug.
Evaluate the arguments for such a policy. (16)
You might find the following web address useful in answering this question.
http://www.edecon.ndo.co.uk/_notes/Drug%20use%20in%20uk%202.doc
Market failure and the economics of alcohol consumption.
An important aspect in the study of economics and business studies is the study of market
failure. Market failure is said to occur when the market mechanism leads to an inefficient
allocation of resources.
Where markets fail the government must take some action to correct this market failure.
In this case study we will look at the market failure associated with the consumption of alcohol
and look at the effects of government measures to correct this market failure.
Alcohol use and misuse in the UK.
Drinking alcohol is a popular pastime in the UK and NI, however compared to our European
partners we actually drink less alcohol per person per week.
The UK ranks 12th out of 19 major European countries and the USA, based on the number of
units of alcohol consumed by the average person each week.
Despite this the government recently commissioned a report into the costs of alcohol use in the
UK.
They did this because they were concerned, not about the quantity of alcohol consumed, but
about the manner in which it is consumed.
Binge drinking – were someone consumes a large amount of alcohol in a short period of time
with the intention of becoming drunk - is on the increase in the UK especially amongst young
people, and it is this which really concerns the government.
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The chart below shows how alcohol consumption in the UK has changed since 1900.
(source: www.number10.gov.uk)
It is clear from this graph that alcohol consumption has increased dramatically over the last 40
years.
Alcohol: a demerit good?
Alcohol is an example of what economists call a demerit good.
Use your class notes, textbook or the Internet to find a clear definition of the term demerit good.
(You could use the bized glossary @ www.bized.ac.uk/glossary/index.htm to get a good
definition).
1. Demerit good:
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External costs:
The consumption of demerit goods like alcohol often confer negative externalities or external
costs on society and therefore economists would argue that they will be over consumed if left to
the free market.
Use your class notes, textbook or the Internet to find a clear definition of the terms negative
externality or external cost.
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(You could use the bized glossary @ www.bized.ac.uk/glossary/index.htm to get a good
definition).
2. External cost/negative externality:
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3. Using the table below try to list the private and external costs and benefits associated
with the use/misuse of alcohol.
Private costs
External costs
Private benefits
External benefits
4. What does the table suggest about the balance of costs and benefits associated with
the consumption of alcohol?
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5. Does this necessarily mean that the government should take stronger action to reduce
the consumption of alcohol? Explain your answer.
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Reducing the consumption of alcohol.
6. List three measures that the government currently takes to reduce the consumption of
alcohol.
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Tax on alcohol:
One method the government currently uses to reduce the consumption of alcohol is taxation. In
the UK indirect taxes such as excise duty and VAT are imposed on alcohol in order to reduce
consumption.
7. Use the diagram below to explain how imposing excise duty on alcohol will reduce its
consumption.
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The table below shows UK duties on alcohol compared with the rest of the EU.
Table 1: EU duty rates on alcohol 2001.
Country
Austria
Belgium
Denmark
Finland
France
Germany
Greece
Ireland
Italy
Luxembourg
Netherlands
Portugal
Spain
Sweden
UK
Beer/Pint
7
8
18
56
5
4
6
39
7
4
8
6
3
31
33
Wine/75cl
Nil
0.25
0.49
1.23
0.02
Nil
Nil
0.25
Nil
Nil
0.25
Nil
Nil
1.53
1.12
(source: www.IFS.org.uk )
Spirits/70cl
1.41
3.23
7.20
9.81
2.82
2.54
1.79
5.41
1.26
2.03
2.93
1.58
1.34
10.53
5.48
8. Using the data above compare the duty on beer, wine and spirits in the UK with that of
France.
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Too much tax?
Since the completion of the single market in 1992, it has become easier for people in the UK to
take advantage of lower priced goods across national borders.
Alcohol is one good where there has been particular concern about the level of cross border
shopping because of the difference in tax rates between the UK and France.
HM customs and excise estimate that in 2000 £290 million of tax revenue was lost to cross
border shopping, this contrasts with £10.86 billion of total revenue collected from alcohol duty.
Local brewers have used these figures to call on the chancellor to reduce the level of duty on
alcohol in the next budget.
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They argue that the government would actually gain revenue by cutting the level of tax on
alcohol, since cross border shopping would be reduced and more revenue would be collected
from the increase in domestic sales.
The idea that a cut in tax rates could actually lead to an increase in tax revenue is based on the
writing of Professor Art Laffer.
In his theory on the Laffer curve he suggested that as taxes increased from relatively low
levels, tax revenue would increase. However their would come a point, where the tax rate
become so high, that people would avoid paying the tax (in this case by shopping abroad) and
therefore tax revenue would actually fall.
9. In the space below sketch a typical Laffer curve and explain its shape.
(You could use the bized glossary @ www.bized.ac.uk/glossary/index.htm to get a good
explanation).
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However Zoë Smith, of the institute of fiscal studies, refutes the claim that reducing tax rates on
alcohol would lead to an increase in tax revenue for the treasury.
She claims that the data in the table below shows that a cut in alcohol duty would actually lead
to a fall in tax revenue.
She goes on to claim that in fact, the data shows that the chancellor could get more revenue by
increasing the tax rates on beer and spirits.
The table below gives data on the price and cross price elasticity of demand for beer, wine and
spirits.
The numbers in the table show the change in quantity demanded of the drinks in each column,
with respect to changes in the price of the drinks in each row. The diagonal elements in bold are
the own price elasticities.
The table also shows cross price elasticities. For example the number in the first row of the
wine column shows the change in the quantity of wine demanded with respect to a change in
the price of beer.
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Table 2: Price and cross price elasticity of demand for beer wine and spirits 2001.
Beer
Wine
Spirits
Beer
-0.76
-0.77
-0.2
Wine
-0.6
-1.69
0.77
(source: www.ifs.org.uk )
Spirits
-0.59
0.66
-0.86
10. Table 2 gives data for price and cross price elasticity of demand. Explain what these
two concepts measure.
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Zoë Smith from the institute of fiscal studies states that the government would gain revenue by
increasing duty on beer and spirits, but not wine.
11. Using the data in table 2 explain why increasing the duty on wine would not lead to an
increase in the tax revenue from wine.
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12. From the data in table 2 select two goods, which could be described as substitutes
for each other. Explain your answer.
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13. In groups of three or four choose one policy from the list below and present a
coherent evaluation of that policy as a means of reducing the problems associated with
the consumption of alcohol.
1.
2.
3.
4.
5.
Increase the tax on alcohol
Increase the age restriction from 18-21
Extend pub opening hours
Ban alcohol advertising
Ban alcohol
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