Up in Smoke: Cigarettes and Externalities

Katie Jo Hibbs


Cigarette smoking has been a popular pastime for centuries. In the past, people would typically buy their cigarettes from small local stores. As larger retailers emerged, the smaller stores became concerned that they could not compete if the larger stores began to sell cigarettes at discount prices. To help ensure fair competition between the various tobacco retailers, states began to enforce minimum price laws on cigarettes. These price floors were placed at a time when governments were not particularly concerned about the health costs of cigarette smoking. However, in the 1950’s and 60’s medical research began linking smoking to cancer and other health problems. At the same time, Medicare and Medicaid left the government responsible for treating all the ailments caused by smoking. In fact, recently “all fifty states filed suit against the tobacco industry on the grounds that smokers generate extra health care costs that must be borne by state governments” [2]. With an ever-increasing life span of the average American, the healthcare costs associated with smoking have continued to sky-rocket.

Studies show that the “price of cigarettes is significantly related to their consumption: when cigarette prices rise, people tend to smoke less or quit” [3]. To take advantage of this fact, excise taxes have been imposed on cigarettes. This “sin tax” has resulted in fewer smokers due to the increased costs of supporting the habit. The decrease in smoking and the price floor on cigarettes has resulted in both a positive and negative externality. According to the American Lung Association, “the average smoker dies seven years earlier than the average nonsmoker, which means that smokes pay into Social Security and private pension funds for all of their working lives but then don’t stick around very long to collect the benefits” [1]. While society has experienced a positive externality of fewer smokers and lower healthcare costs, the tobacco industry has experienced the negative effect of lowered profits.

Studies estimate that “over 90% of smokers in the U.S. start smoking in their teenage years” [5]. This is because consumers, especially young ones, “don’t rationally weigh the benefits of something enjoyable (utility) against future health risks and other costs (externalities)” [1]. Public campaigns aimed at lowering smoking, particularly among children, have been very successful. Even though “consumers will not think about the negative effects that the consumption will have on third parties, they will only think about the benefits/costs to them,” medical findings related to second hand smoke combined with increasing demands for smoke-free restaurants and workplaces have led to lower prohibiting smoking in most public buildings [4]. This partial ban on smoking has put further pressure on people not to smoke.

The recent introduction of Electronic Cigarettes (or E-Cigs), has left policy makers in somewhat of a quandary: E-Cigs have decreased the number of “real” smokers, but at what costs (externalities)? The long term health risks of E-Cigs are not clear, yet there are already calls for excise taxes and partial bans on E-Cigs. However, a recent study in the journal Addiction found that “E-Cigarette users were more likely to give up real cigarettes” [6]. Maybe E-cigs should be subsidized instead of taxed! While the increasing sales of E-Cigarettes will likely cause serious negative externalities for tobacco companies, the overall benefit to society may far outweigh the cost.


Citation (Image): 6 Ways to Save on Cigars, June 15, http://www.cheaphumidors.com/blog/how-to-2/6-ways-save-on-cigars/


  1. Charles Wheelan, Naked Economics: Undressing the Dismal Science (New York: W. W. Norton & Company, 2010), 27.
  2. Charles Wheelan, Naked Economics: Undressing the Dismal Science (New York: W. W. Norton & Company, 2010), 59.
  3. Cigarette Minimum Price Laws,” publichealthlawcenter.org, 2011, Accessed June 14, 2016. http://publichealthlawcenter.org/sites/default/files/resources/tclc-guide-cigminimumpricelaws-2011.pdf.
  4. “Sophia H Economics,” sophiaeconomics.wordpress.com, February, 6, 2013, Accessed June 14, 2016. https://sophiaheconomics.wordpress.com/2013/02/06/negative-externalities-of-smoking/.
  5. “Justifying the Tobacco Tax,” swarthmore.edu, 2002, Accessed June 14, 2016. http://www.swarthmore.edu/writing/justifying-tobacco-tax.
  6. “Taxing E-Cigarettes Seems Crazy,” June 5, 2014, Accessed June 14, 2016. http://www.forbes.com/sites/taxanalysts/2014/06/05/taxing-e-cigarettes-seems-crazy/#4be9c0c3fc3e.



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