Minimum price on alcohol
Governments in Australia and around the world are considering implementing a minimum price (aka price floor) on alcohol. Your task is to use the Economic way of thinking learnt in class to formally explain the effect of the minimum price. You will need to consider the external effects (negative externalities) of alcohol consumption, the price elasticity of demand, and taxation (an alternative way of reducing alcohol production/consumption). To simplify analysis, please assume that alcohol is a single homogenous good. That is, do not differentiate between different types of alcohol and packaging (wine, beer, casked wine, spirits etc.).
For background information read the following articles:
https://theconversation.com/minimum-price-on-alcohol-in-the-nt-will-likely-reduce-harm-92577
http://www.abc.net.au/news/2017-10-21/alcohol-floor-price-considered-tackle-abuse-wa/9071544
Questions:
1. Using demand and supply for alcohol, explain why the market outcome may not be efficient. [Think about externalities. What are some of the external costs imposed on society from excessive alcohol consumption?]
2. Explain how a well enforced price floor could affect the market for alcohol and how consumption could adjust to an efficient level. [You can assume that firms understand market demand and will only produce the amount demanded at the price floor.]
3. Now suppose that instead of using the price floor to restrict consumption, the government decides to impose a tax on alcohol ($x on each unit of alcohol sold).
a. Can such a tax achieve an efficient level of consumption? Explain.
b. In light of your answer to part a, if you were advising the government, would you recommend implementing a price floor or tax to achieve the efficient level of consumption? [Hint: think about tax revenue.]
4. Is the demand for alcohol elastic or inelastic? Explain. How are your answers to Question 2 and 3 affected by the price elasticity of demand?
5. Suppose that changing climate increases the price of hops (an input in the production of alcohol). How will this affect the market for alcohol? Assuming that the price floor or tax on alcohol sales is operating, what does the government need to do in order to maintain an efficient level of alcohol consumption?