1.2.9 Indirect Taxes and Subsidies Flashcards
define indirect taxes
a tax imposed on expenditure, such taxes increase costs to firms and so cause the supply curve to shift left
what are the two types of indirect tax
- ad valorem (percentage of price e.g VAT)
- specific tax (set amount)
what are some of the main indirect taxes in the UK
- VAT
- tobacco duties
what is the consumer burden
how much of the tax is passed onto the consumer in the form of higher prices
what is the producer burden
how much of the tax is paid by the producer
how is consumer burden shown on a diagram
area below new equilibrium and above old equilibrium
how is producer burden shown on a diagram
area below old equilibrium and above P3 (price where new equilibrium meets old supply)
what is the effect of an indirect tax if demand is price elastic
firms have less scope to raise price after a tax
most of the burden of an indirect tax will be absorbed by the supplier
what is the effect of an indirect tax if demand is price inelastic
producers can shift the burden of the tax to the consumer
most of the indirect tax will be passed on to the final consumer
define an ad valorem tax
imposes a tax on a good or asset, depending on its value. the tax is usually expressed as a percentage
give an example of an ad valorem tax
VAT at 20%
how do we show an ad valorem tax on a diagram
shift supply inwards and make it more inelastic
define a regressive tax
a tax imposed by a government which takes a higher percentage of someone’s income from those on low incomes
what are the justifications for using indirect taxes
- 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
how is government revenue shown
consumer burden + producer burden
when will indirect taxes generate most government revenue
if PED is inelastic
Define a subsidy
Any form of government support - financial or otherwise - offered to producers and (occasionally) consumers.
What is the effect of a subsidy on producers
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.
Which price does the consumer pay
P2
Which price does the producer recieve
P3
What shows the value of the subsidy
The vertical distance between the supply curves
What is the total cost of the subsidy to the government
P3P2 x Q2
What is the effect of a subsidy if demand is price inelastic
Only a small expansion in demand when the price drops
What is the effect of a subsidy if demand is price elastic
Can have a big effect on the equilibrium quantity bought at a lower price
What are some key justifications for subsidies
- 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
What are some key drawbacks of subsidies
- 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
