Tobacco Regulation and Cost-Benefit Analysis: How Should We Value Lost Consumer Surplus?

Recent tobacco regulations proposed by the Food and Drug Administration have raised a thorny question:  how should the cost-benefit analysis accompanying such policies value foregone consumer surplus associated with regulation-induced reductions in smoking?  In a model with rational and fully-informed consumers, this question is relatively straightforward.  There is considerable disagreement, however, about whether consumers are either rational or fully informed, and the literature offers little practical guidance about what approach the FDA should use if they are not.  In this paper, we outline the history of FDA’s recent attempts to regulate cigarettes and other tobacco products and how they have valued foregone consumer surplus in cost-benefit analyses.  We review the evidence on whether consumers are fully informed about the risks of smoking and whether their choices are rational, reviewing the competing arguments made by different authors about these questions.  We discuss the appropriate treatment of foregone consumer surplus under different assumptions about consumer information and rationality.