Adverse selection model regarding tobacco consumption

The impact of introducing a tax on tobacco consumption can be studied trough an adverse selection model. The objective of the model presented in the following is to characterize the optimal contractual relationship between the governmental authorities and the two type employees: smokers and non-smokers, taking into account that the consumers’ decision to smoke or not represents an element of risk and uncertainty. Two scenarios are run using the General Algebraic Modeling Systems software: one without taxes set on tobacco consumption and another one with taxes set on tobacco consumption, based on an adverse selection model described previously. The results of the two scenarios are compared in the end of the paper: the wage earnings levels and the social welfare in case of a smoking agent and in case of a non-smoking agent.