A Cigarette-Switching Model: Derivation and Numerical Simulation

Abstract

I propose a cigarette-switching model, which explains key variables, and parameters that influence a change in consumption of any category of cigarettes with the ultimate goal of estimating the drivers behind the consumption of smuggled cigarettes and determining what variables to adjust to reduce the ultimate switching of consumers to smuggled cigarettes, hence amount of smuggled cigarettes in the economy. This paper has provided insight into the response of various categories of cigarettes to changing values of parameters that affect them at each level. First, the simulation revealed that in the No-Alternative Equilibrium (NAE), domestically produced cigarettes will keep rising and remain stable while in the endemic equilibrium, the domestically produced cigarettes will face competition from imported, smuggled, and underground cigarettes which will lead to a slight reduction in the amount of domestically produced cigarettes. Secondly, a rising local excise tax rate leads to a reduction in domestically produced cigarettes, however; the trend is stable (in contrast to declining) so long as the smoking participation rate is higher than the cessation rate-a fact that holds in this case. Third, an increase in the import excise tax rate to 60 percent and beyond will lead to a reduction in imported cigarettes. Similarly, below import excise of 50 percent, smuggled cigarettes will rise with increasing tax rate however, beyond 60 percent, smuggled cigarettes start declining thereby exhibiting a Laffer-effect of import excise on amount of smuggled cigarettes. Lastly, there is an interesting observation regarding the effect of the probability of detection on smuggled cigarettes. Alone, even if the probability of smuggling triples, it is not sufficient to lead to a reduction in smuggled cigarettes. Only when paired with increasing taxes, does the probability of detection gain significance and strength in the reduction of smuggled cigarettes. Hence, the two produce great synergy effective at curbing cigarette smuggling.