1.2 - Indirect taxes and subsidies

Question 1

Indirect tax

Answer 1

Tax on spending
> levied onto producers by government
> consumers and producers each pay a share (incidence)

Question 2

Types of indirect tax

Answer 2

• AD valorem tax
• Specific tax

Question 3

Ad valorum tax

Answer 3

A tax that is a percentage of the purchasing price
> Eg: value added tax (VAT)

Question 4

Specific tax

Answer 4

A tax on a fixed amount for each unit of the good/service sold

Question 5

What is the incidence of tax?

Answer 5

Who burden of tax falls onto
> producers may increase prices so that consumers pay a share of the tax

Question 6

What is specific tax common on?

Answer 6

Demerit goods

Question 7

What does the amount of tax passed onto consumers from producers depend on?

Answer 7

Price elasticity of the good/service
> assuming firms are profit maximisers,
> producers pass on as much of the tax onto consumers by selling at a higher price
> for price inelastic products, producers pass on a much higher proportion of the tax on consumers because quantity demanded falls by a much lower proportion than the increase in price
> for price elastic products, producers pass on a much smaller proportion of the tax to consumers and pay the rest themselves
because quantity demanded decreases but by a larger proportion as it is very responsive to an increase in price

Question 8

Subsidy

Answer 8

A grant given by the government to a firm to increase the production and provision of this good
(by lowering production costs)

Question 9

What are subsidies common for?

Answer 9

merit goods

Question 10

What is a limitation of a subsidy?

Answer 10

> Opportunity cost - government spending could be used elsewhere
Uses government budget