Addiction as a market failure: using rational addiction results to justify tobacco regulation

Tobacco regulation efforts have been criticized by some academic economists for failing to provide adequate welfare-analytic justification. This paper attempts to address these criticisms. Unlike previous research that has discussed second-hand smoke and health care financing externalities, this paper develops the logic for identifying the much larger market failures attributable to the failure of smokers to fully internalize the costs of their addictive behavior. The focus is on teen addiction as a form of "intrapersonal" externality and observed adult consumption behavior consistent with partial myopia. The importance of peer effects, in the consideration of welfare impacts, is also emphasized.