BACKGROUND: There is a low number of cross-price elasticity estimates in the literature and no consensus on whether licit cigarette prices affect the consumption of illicit brands. The recent survey on the economics of tobacco regulation by DeCicca et al. (2022) excludes illicit cigarette studies entirely because the topic “has received little attention in the literature”. The authors also cite only a handful of papers that estimate cross-price elasticities between licit and illicit cigarettes and other tobacco products.
METHODS: Using propensity score matching (PSM), we pair comparable licit- and illicit-cigarette consumers to assign hypothetical prices and address the challenge of exclusive consumption of just one type. The analysis focuses on Brazil, a developing country with a significant illicit cigarette market, and uses individual data from the 2013 and 2019 National Health Surveys (PNS). Illicit market identification relies on declared brands and sales below the official minimum prices.
RESULTS: Results show that cross-price elasticities indicate a switching demand effect following illicit cigarette price changes in 2013, but not in 2019. However, changes in licit cigarette prices do not significantly influence switching demand in either year or in the combined sample. Across all models, illicit cigarette consumers exhibit lower price sensitivity than their licit counterparts, highlighting distinct behaviors in response to market dynamics.
CONCLUSIONS: There is no significant evidence that an increase in legal cigarette prices, such as from tax hikes, would lead to an expansion of the illicit market. These results suggest that legal and illegal cigarettes are not close substitutes, as their demand is not directly influenced by their relative prices. The positive cross-price elasticity estimates from the illicit to the licit market also represent a desirable second-order effect of public policies aimed at combating cigarette smuggling.