Decades of public health research have established that cigarette smoking exacts costs on smokers, the people around them, and the environment. In a classic, rational economic model, we would assume that individuals’ consumption of cigarettes is based on the understanding of those negative effects. Smokers know that they have an increased chance of getting lung cancer or heart disease, or that their children and spouse do if they smoke around them. Theoretically, then, smokers choose to consume an amount that factors in these costs. In a classic microeconomic framework, consumers maximize their utility when the costs of that consumption equal the benefits, so the consumers choose to consume the number of cigarettes that generates benefits for them they feel are equal to its cost.
However, consuming cigarettes is not the same as consuming apples. Cigarette consumption does not happen in a vacuum–as is made clear by the effects of secondhand smoke. This classic rational economic model says that consumers only take into account their own costs, not the cost to other people. The negative externality, this additional cost to others that consumers and producers do not consider when participating in the market, is similar to the consequences of consuming many other goods. For example, firms producing energy who expel smog into the air cause climate pollution which negatively impacts everyone else, but their decision to produce the amount they do does not take this into account. There are many examples of negative externalities, and they represent a market failure. Competitive markets work great in theory, but one of the ways they fail is in the presence of an externality.
Since so many goods exact negative externalities on society, there are tried and true methods to combat them. One example is a tax. Cigarettes are taxed by the federal government and states. Theoretically, the size of that tax would be equal to the size of the negative externality, so that people consume at the level equal to the cost to society. Instead, they overconsume, not considering these additional costs. Using secondhand smoke as the example, the size of the tax would encapsulate the cost of secondhand smoke to other people, as well as other negative effects like the cost to the public healthcare system for smokers who develop smoking-related illnesses, or the lost productivity to the economy from smokers dying earlier and not working for as long as nonsmokers.
Taxes work well at reducing smoking in this way, and as they have increased over the years, accompanied by public health campaigns and bans on smoking in most public places, cigarette consumption has greatly fallen. However, 15% of people in Ohio still smoke. The size of the tax is not actually equal to the social costs exacted by it, especially because it is not linked to inflation, so its effective value has degraded over time.
Although taxes are successful at addressing negative externalities that harm others, cigarettes also harm individuals who consume them. In theory, people should account for these personal costs when deciding how much to smoke—but unlike non-addictive goods such as apples, cigarettes have addictive properties that can distort rational decision-making.
Many smokers begin before the age of 18, which used to be the legal age to purchase tobacco. Since the legal age has now increased to 21, anyone who starts smoking earlier is, by the judgment of the state of Ohio, acting irrationally. For example, someone who begins smoking at 15 may develop an addiction that undermines their ability to make the same rational choices they might have made later in life. As adults, they may fully understand the health risks, but their addiction constrains their capacity to respond rationally.
This means that people who are consuming cigarettes now may be making a rational decision to smoke cigarettes when it would be irrational for a nonsmoker to start: based on their addiction, they are smoking the correct amount for themselves. In the absence of addiction, they would smoke less or not at all.
The failure to fully realize the cost of smoking to oneself is called an “internality.” If you do not fully realize how bad cigarettes are for your health, you’re going to overconsume because the “price” of cigarettes is higher than you realize. It’s likely that cigarette consumers understand the consequences to their health in some ways: public health campaigns are wide-reaching at this point and surveys of the American population show that almost everyone knows cigarette smoking is linked to cancer and other negative health outcomes. But it is also likely that they do not fully internalize these costs, perhaps because they underestimate their personal risk, feel a sense of invincibility, or are so addicted that the long-term health consequences weigh less heavily in their decision-making.
While working on a cost-benefit analysis on increasing the cigarette excise tax in Ohio, I have been thinking a lot about how to model rational smoking decision-making in a way that (1) isn’t paternalistic, and (2) appeals to the large body of literature finding that people overconsume cigarettes. During that search, I came across a model in the NBER Working Paper Series from 2015 (Jin, Kenkel, Liu, Wang). The authors model cigarette consumption from 1964 to 2010, comparing observed consumption with two hypothetical scenarios: one reflecting fully rational consumption and another showing how smoking might have continued without new FDA regulations.
Inherent in this model is the assumption that a consumer’s lifetime utility is a function of the health consequences of smoking, even if these consequences are not fully internalized in their decision-making. They argue that these anti-smoking health policies make consumers better off if they are not fully internalizing the health consequences of smoking, but make them worse off if they are. So, the model includes the assumption that consumers might imperfectly optimize their utility because of decision-making errors or bounded self-control, which is an individual’s limited ability to choose future rewards over immediate gratification.
Figure 1 is the graphical depiction of the conceptual framework. This counterfactual curve, the one that represents estimated behavior if anti-smoking policies had not been enacted, is DCFt.t at price Pt, those individuals consume cigarettes at the quantity ACFt in the year t. The actual amount that individuals were observed to have consumed after these policies at that same price is AOt, represented by the curve DOt. The rational curve is the line DRt | At-1, where consumers choose a level of consumption that depends on how addicted they were in time t-1. Those individuals choose the lowest level of consumption, ARt. Rational consumers are those whose decisions are the most fully informed. Research shows that people with higher incomes and college degrees tend to smoke at lower rates and to smoke fewer cigarettes each (Ida 2014; National Research Council (US) Panel on Understanding Divergent Trends in Longevity in High-Income Countries 2010).
The anti-smoking policies, which reduced demand, made consumer spending on cigarettes fall by the area J+K+L. Their net consumer benefits are given by the areas J+K, from the amount that spending falls minus their foregone consumption, L, at this lower value. The policies have immediate benefits, but they also are compounding: since rational consumers are making decisions based on their addictive stock in the last period, consuming fewer cigarettes in the period before will make a consumer smoke less in this period. If consumers moved to the rational curve, they would gain net benefits, G, and would forego consumption H.
Differentiating between observed and rational consumers can help to model the internality that comes with smoking. Taxes are important to address the externality side of cigarettes–that is the effects of secondhand smoke, costs to the environment, and others–but it could also help de-incentivize individuals who, at this current moment, do not fully consider the costs of smoking to their health in the future from consuming as much as they do.