Governments intervene in markets with an aim to address inefficiencies in the allocation of resources. Regulation and taxation are typical strategies through which governments intervene in markets. The recently introduced environmental protection tax in China is a case in point of government intervention in markets. China’s environmental tax has wide-ranging implications on IKEA and the other companies that discharge pollutants directly to the ecosystem.

Overview

IKEA is the world’s largest manufacturer of wood-based furniture. It has 40 manufacturing units based in ten countries including China. The furniture market where IKEA operates falls into the classification of a monopolistic market. A monopolistic market structure exists in conditions when many firms compete against each other by selling products of the same nature but that are distinctive in certain aspects. The furniture industry has many players where all are offering the same products, which, however, are differentiated. For example, IKEA differentiates its furniture products by presenting them as eco-friendly and simple in design. Thus, consumers perceive a difference between IKEA’s and competitors’ furniture.

Possible Government Interventions

Furniture factories emit a range of pollutants into the ecosystem. These pollutants include greenhouse gases, odors, smoke, fumes, solid waste, and particulate matters. Without regulation, the cost of pollution is borne by the society. To force furniture manufacturers to internalize the cost of pollution in their decision-making, governments may impose environmental taxes or emission caps. Emission caps, such as those imposed by the European Union, require firms to purchase permits in order to cover different volumes of emissions. Environmental taxes impose a direct charge that is proportional to the amount of pollution. Both emission caps and environmental taxes raise the cost of production for firms  purchase college research papers.  Depending on the nature of price elasticity of the demand, the firms may pass additional costs to consumers by raising prices or, alternatively, absorb additional costs. In either case, emission caps and environmental taxes address the failure of markets to incorporate the detrimental impacts of pollution in production and consumption decisions.

China’s Environmental Protection Tax

With effect from 1 January 2018, China will levy an environmental protection tax (EPT) on firms that emit noise and dispose of water pollutants, air pollutants, and solid waste directly to the environment. Each of the four regulated pollutants will be taxed at a distinctive rate that will be determined by the government of the provincial jurisdiction where a firm is located. The taxation rate for specified quantities of air pollutants range from 1.2 to 12 yuan: 1.4-14 yuan for water pollutants and 5-1000 yuan for solid waste. China’s EPT is intended to achieve lower levels of pollution. Pollution is a form of market failure in view that, in the absence of environmental protection tax and similar regulations, the society bears the detrimental costs of pollution. China’s EPT intends to provide motivation for manufacturers including IKEA in order to reduce their environmental impacts. Since the EPT is commensurate to the level of generated pollution, IKEA and the other manufacturers have an incentive to produce responsibly.

When firms experience the increase in production costs due to the imposition of taxes, they can absorb costs or pass them to consumers depending on the price elasticity of the product demand. The furniture industry where IKEA operates is monopolistic since there are many firms selling essentially similar but differentiated products. Due to this differentiation, a monopolistically competitive firm can increase prices without losing all of its customers to competitors or reduce prices to attract more customers. Thus, a monopolistically competitive firm has some degree of price discretion to the extent that consumers view its products as different from those offered by the competitors.

Figure 1 Figure 2

Figure 1 depicts the demand curve of a firm operating in a monopolistic market while figure 2 shows the demand curve of a monopolist. Due to the existence of substitutes in a monopolistic market, monopolistically competitive firms have more elastic demand curves than those of monopolies that do not have close substitutes. If a monopoly increases its prices, some consumers will avoid buying its products. Conversely, if a monopolistically competitive firm increases its prices, some consumers will avoid buying its products altogether while the others will choose to buy similar products from the competitors, thus leading to a higher decline in sales, which would be a case for a monopoly. However, since China’s EPT affects the entire furniture industry, not just IKEA but all furniture manufacturers would have to increase their prices to offset additional production costs. Taking into consideration the durability nature of furniture and the discretionary nature of its demand, the loss of consumers in this case would be attributed to their decision to stop or postpone purchasing new furniture, repairing old furniture or buying pre-used furniture. To avoid the downward impact on demand for the new furniture and subsequent decline in sales, IKEA and other furniture manufacturers would opt to absorb the cost of environmental tax rather than pass the cost to consumers.

Winners and Losers

IKEA and other manufacturers will lose from China’s environmental protection tax as it will increase manufacturers’ costs of production. Due to the relatively high price elasticity of furniture, any attempt to pass additional costs to consumers will result in a disproportional reduction in the demand for new furniture. Subsequently, manufacturers will be forced to bear the cost of the tax. Consumers and the society will be winners from the imposition of China’s EPT since they will not pay higher prices for IKEA’s furniture as the firm will be unable to incorporate the EPT cost in market prices. In the end, IKEA will need to adopt more environmentally-friendly production methods in its factories. Therefore, the society will be safeguarded from the detriments of high pollution levels.

Conclusion

Pollution is a negative externality generated by the production process. The aim of China’s environmental protection tax (EPT) is to compel IKEA and other manufacturers to internalize the societal cost of pollution in their production decisions. Due to the elasticity of the furniture demand, IKEA and other furniture manufacturers will be forced to absorb the cost of the environmental tax since shifting it to consumers through price increase will lead to the decline in demand and sales of new furniture. Thus, manufacturers will need to use efficient production methods in order to reduce their pollution discharges and, consequently, the payable environmental tax.