Last Thursday, the South Korean government proposed to increase tobacco taxes for the first time in a decade, a bill which when approved by the National Assembly would nearly double current tobacco prices, from 2,500 to 4,500 Korean Won for an average pack of cigarettes. This tax hike would allegedly catch two birds with one stone, securing extra tax revenue for the government and curbing the smoking rate in a country with some of the heaviest smokers in the world; but opponents of the bill argue that the policy has its fair share of side effects, on smokers and even on Tobacco companies themselves. In fact, shares of Korea's leading tobacco provider Korea Tobacco & Ginseng Corporation (KT&G), a formerly state-run company that accounts for nearly two-thirds of the country's cigarette sales, fell 5.6%.

Of course, it is inevitable that a steep increase in tobacco prices results in a decrease in demand. However, the demand for demerit goods such as tobacco tend to be extremely inelastic, meaning that a change in the price of tobacco has little impact on its demand, due to the fact that tobacco is an addictive product; the government would likely have taken this fact into account when deciding on the extent of the price increment. Furthermore, some of the demand KT&G may lose as result of the price hike could be recuperated in the long run. Smokers will undoubtedly be angered but once the policy is actually put into place most will likely find a way to adjust their finances to fund their tobacco purchases, as it does not constitute a large part of household spending. In 2004, the last time the government imposed extra taxes on cigarettes, KT&G's profits dropped from 1.02 trillion to 676 billion Korean Won in the space of a year, but managed to reach similar levels 3 years later.

That being said, it may take a bit longer for KT&G's profit to rebound from a potential dip in the market this time round. Back in 2004, prices were increased by 25 percent but this time the government upped the ante by a whopping 80 percent. So no matter how inelastic the demand is for tobacco, there will be a longer time lag for the inelasticity to settle in.

Here it should be re-emphasized that KT&G's profit rebound a few years back did not mean exactly the same for the demand for their products. As a matter of fact, a high demand should not necessarily be the ultimate goal of the company - profit, hence revenue is. And revenue depends not only on demand but on the price of the product as well. In other words, even if there is a drop in demand for tobacco the overall revenue could increase as a result of the aforementioned price surge.

Yet at a superficial glance, one may think KT&G would not reap most of the benefits of the 2000 Korean Won price surge, as the policy is more of a tax hike rather than a price hike; out of the 2000, 1768 is attributed to increases in taxes while 50 is attributed to increases in the factory price. The government will allow KT&G to make any price changes within the range of 50 Korean Won, which may seem like pennies on the dollar compared to the final retail price, but this comparison is meaningless from the company's point of view. The company does not benefit from any component of the tobacco price other than the factory price, which added to the retail margin is currently a mere 950 Korean Won; therefore a potential increase of 50 Korean Won would have a more significant impact on the company's profit than meets the eye. Experts estimate that a 50 Korean Won increase in the factory price would bring KT&G extra profits of around 9.4 percent. It looks like although the government is bent on bringing down the number of smokers it has not disregarded the interests of the tobacco companies.