1.2.9 Indirect taxes and subsidies + Maximum and minimum prices

Question 1

An indirect tax is

Answer 1

a tax imposed by the Government that increases the supply costs faced by producers

Because of tax, less can be supplied at each price level

Question 2

An indirect tax will increase the price of a product, which will do what to quantity demanded

Answer 2

reducing the quantity demand of a product

Question 3

Does a tax cause a movement along the demand curve, or a shift in the demand curve

Answer 3

Movement along the demand curve

Question 4

An indirect tax on suppliers will have no effect on market price when ….

Answer 4

demand is perfectly elastic, although the equilibrium quantity will fall significantly

Question 5

How much of the indirect tax, if any, will be passed on to the consumer, when demand is perfectly inelastic

Answer 5

All of the tax will be passed onto consumers

There will be no change in equilibrium quantity, but a large increase in equilibrium price

Question 6

What is a specific/unit tax

Answer 6

is a set tax per unit

e.g. £5 per unit

Question 7

What effect does a specific/unit tax have on the supply curve

Answer 7

causes a parallel shift in supply curve

Question 8

What is an Ad Valorem Tax

Answer 8

is a percentage tax

e.g. 20% on unit price

Question 9

What affect does an Ad Valorem tax have on the supply curve

Answer 9

causes a pivot shift

i.e. non-parallel shift in supply curve

Question 10

If co-efficient of price of demand >1

Price is …..

and most of the indirect tax will be

Answer 10

elastic

tax will be absorbed by the supplier

Question 11

If co-efficient of price of demand <1

PED is …..

most of an indirect tax

Answer 11

inelastic

tax can be passed on to the consumer

Question 12

describe a graph for a tax implemented of elastic demand

Answer 12

Question 13

describe a graph for tax implemented on inelastic demand

Answer 13

Question 14

Describe a graph, when tax is implemented on perfectly inelastic demand

Answer 14

All of the tax is paid by the consumer

Question 15

Describe the graph for perfectly elastic supply

Answer 15

All of the tax is paid by the consumer

Question 16

Give 2 examples of Ad Valorem tax

Answer 16

VAT

Insurance premium Tax

Question 17

Describe the movement for the supply curve of an Ad Valorem

Answer 17

causes a pivotal shift in supply curve

This is because tax is a percentage of good price

The absolute amount of the tax will go up as market price increase

Question 18

Give example of subsidies

Answer 18

Biofuel subsidies for farmers

Solar panel “Feed-in Tariffs”

Apprenticeship schemes

Aid to businesses making losses

Childcare for working families

Subsidies for public transport

Question 19

What is a subsidy

Answer 19

any form of Government support, offered to producers

It does not have to be repaid

Question 20

How does a subsidy paid to a producer, affect the supply curve and market equilibrium

Answer 20

causes an outward shift of the supply curve

leading to a lower equilibrium price and increase in quantity traded

Question 21

How much do the producer and consumer pay individually, when a subsidy is added

Answer 21

P1 -P3 = Producer

P1 - P2 = Consumer

Question 22

Reasons for Subsides

Answer 22

• Reduces price, increase quantity
• Leads to an increase in production/consumption of merit goods
• Encourages firms to take part in activities that are beneficial
• In long term, subsidies are good for changing consumer preferences
• Encourage firms to develop more products with positive externalities

Question 23

Reasons against subsidies

Answer 23

• The money to pay for subsidies will have to come from taxation
• All subsidise have opportunity costs
• Externalities contain a level or value judgment, therefore it is hard to work out the level of subsidy to give
• The Government will have likely have complete information
• May cause firms to become inefficient through relying on subsidies
• Depends on size of subsidy, how long the subsidy is given and elasticity of the market

Question 24

How will demand being inelastic affect subsidies

Answer 24

The subsidy has a larger effect on equilibrium price

Question 25

How will demand being elastic affect subsidies

Answer 25

Subsidy has a stronger effect on equilibrium quantity

Question 26

Reasons for Taxations

Answer 26

* Target particular industries - making polluters pay * Used an incentive to reduce externalities * Based on the principle of making polluters pay * Tax funds Government can be used for positive outcomes * Size of externality should fall, as output of good/services is reduced and price increase

Question 27

Reasons against taxations

Answer 27

* Difficult for Government to give fixed monetary value on an externality, hence hard to decide optimum level * Not all costs/externalities can be split this way * Firms may move away to counties with lower taxes * demand may be price inelastic * Tax may not be used to compensate victims * Encourage the development of illegal markets

Question 28

What is a Maximum price

Answer 28

This is a legally imposed maximum price in a market that suppliers cannot exceed

Question 29

To be effective a Maximum must ...

Answer 29

has to be set below market equilibrium Leads to **excess demand** and shortage in supply Excess supply cannot be cleared by market forces since Max price level prevents this this

Question 30

For Maximum price to work, you need excess demand the amount of excess demand depends on ...

Answer 30

Price elasticity of demand Price elasticity of supply

Question 31

Describe a S&D diagram for Max price

Answer 31

In the diagram above the free market price is P1. If a maximum price is imposed, quantity supplied contracts from Q1 to Q3 whilst quantity demanded expands from Q1 to Q2. Therefore, a maximum price drawn beneath the equilibrium price leads to a disequilibrium with excess demand equal to the quantity Q3-Q2.

Question 32

What are the benefits of Maximum price

Answer 32

* Would stop some consumers being priced out of the market * Leads to lower price for consumer * Max price can help increase fairness, allowing more people to purchase certain good/service * Max prices be used to prevent monopolies exploiting customer/supplier with high prices * reserved for important goods such as food and rent

Question 33

What are 6 limitations of maximum price

Answer 33

* Lead to secondary, unofficial market because of scarcity of supply, meaning consumers are willing to pay over regulated price * Includes a normative judgment of max price * Possble reduction in quality of goods * Secondary effects on public due to reduced supply - as there is shortage * Government may need to introduce a rationing scheme to allocate goods * Depend on PED and PED and how beneficial is it and what should the price level should be, how long will the max price be in place for

Question 34

What is a minimum price

Answer 34

Is a price-floor, which is legally imposed, which the normal market price cannot fall below

Question 35

An example of a minimum price

Answer 35

minimum wage Unit price in Scotland of alcohol

Question 36

A minimum price is an attempt to

Answer 36

reduce demand

Question 37

For minimum price to work it must ...

Answer 37

be set above free-market equilibrium, so it will reduce demand and increase supply, leading to excess supply

Question 38

What must the government do, for minimum price to work

Answer 38

Government might buy excess supply at fixed prices

Question 39

What will impact the effectiveness of a minimum price

Answer 39

Price elasticity of supply Price elasticity of demand

Question 40

Describe a graph for minimum price

Answer 40

Price is set above P1 However market forces cannot push price down, due to the minimum price, creating excess supply Quantity demanded is decreased from Q2-Q1 Q3 is the quantity supplied

Question 41

Describe benefits for Minimum price

Answer 41

* Reduces social externalities of over-consumption of demerit goods * Businesses would benefit from higher revenue * Protects businesses in theory

Question 42

Describe drawbacks for minimum price

Answer 42

* Demand for services may be inelastic * Require additional spending and enforcement * Higher prices for consumers * Higher tariff necessary on imports to keep prices higher * What do you do with oversupplied product