1.2.9 Indirect Taxes and Subsidies

Question 1

define indirect taxes

Answer 1

a tax imposed on expenditure, such taxes increase costs to firms and so cause the supply curve to shift left

Question 2

what are the two types of indirect tax

Answer 2

• ad valorem (percentage of price e.g VAT)
• specific tax (set amount)

Question 3

what are some of the main indirect taxes in the UK

Answer 3

• VAT
• air passenger duty
• tobacco duties
• landfill tax

Question 4

what is the consumer burden

Answer 4

how much of the tax is passed onto the consumer in the form of higher prices

Question 5

what is the producer burden

Answer 5

how much of the tax is paid by the producer

Question 6

how is consumer burden shown on a diagram

Answer 6

area below new equilibrium and above old equilibrium

Question 7

how is producer burden shown on a diagram

Answer 7

area below old equilibrium and above P3 (price where new equilibrium meets old supply)

Question 8

what is the effect if demand is price elastic

Answer 8

firms have less scope to raise price after a tax
most of the burden of an indirect tax will be absorbed by the supplier

Question 9

what is the effect if demand is price inelastic

Answer 9

producers can shift the burden of the tax to the consumer
most of the indirect tax will be passed on to the final consumer

Question 10

define an ad valorem tax

Answer 10

imposes a tax on a good or asset, depending on its value. the tax is usually expressed as a percentage

Question 11

give an example of an ad valorem tax

Answer 11

VAT at 20%

Question 12

how do we show an ad valorem tax on a diagram

Answer 12

shift supply inwards and make it more inelastic

Question 13

define a regressive tax

Answer 13

a tax imposed by a government which takes a higher percentage of someone’s income from those on low incomes

Question 14

what are the justifications for using indirect taxes

Answer 14

• a key source of tax revenue to pay for overall government spending
• can be used to change consumer and producer behaviour which might alter the pattern of demand for goods and services
• helps to address examples of market failure
• indirect taxes such as import duties can be used to improve a countries trade balance

Question 15

how is government revenue shown

Answer 15

consumer burden + producer burden

Question 16

when will indirect taxes generate most government revenue

Answer 16

if PED is inelastic

Question 17

Define a subsidy

Answer 17

Any form of government support - financial or otherwise - offered to producers and (occasionally consumers).

Question 18

What is the effect of a subsidy on producers

Answer 18

Reduces the marginal cost of supply
Usually leads to an increase in the output sold of a good or service at a lower market price.

Question 19

Which price does the consumer pay

Answer 19

P2

Question 20

Which price does the producer recieve

Answer 20

P3

Question 21

What shows the value of the subsidy

Answer 21

The vertical distance between the supply curves

Question 22

What is the total cost of the subsidy to the government

Answer 22

P3P2 x Q2

Question 23

What is the effect of a subsidy if demand is price inelastic

Answer 23

Only a small expansion in demand when the price drops

Question 24

What is the effect of a subsidy if demand is price elastic

Answer 24

Can have a big effect on the equilibrium quantity bought at a lower price

Question 25

What are some key justifications for subsidies

Answer 25

• helps poorer families with food and childcare costs
• encourages output and investment in fledgling sectors
• protects jobs in loss-making industries hit by a recession
• positive externalities
• achieves a more equitable income distribution
• reduces cost of training and employing younger workers

Question 26

What are some key drawbacks of subsidies

Answer 26

• producers can become subsidy dependent
• can distort resource allocation (waste of resources as there is not actual demand)
• can lead to excess production/surpluses
• environmental risks from excessive production
• government failure arising from political lobbying
• can be very expensive for tax payers