1.2.9 Indirect taxes and subsidies + Maximum and minimum prices Flashcards
An indirect tax is
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
An indirect tax will increase the price of a product, which will do what to quantity demanded
reducing the quantity demand of a product
Does a tax cause a movement along the demand curve, or a shift in the demand curve
Movement along the demand curve
An indirect tax on suppliers will have no effect on market price when ….
demand is perfectly elastic, although the equilibrium quantity will fall significantly
How much of the indirect tax, if any, will be passed on to the consumer, when demand is perfectly inelastic
All of the tax will be passed onto consumers
There will be no change in equilibrium quantity, but a large increase in equilibrium price
What is a specific/unit tax
is a set tax per unit
e.g. £5 per unit
What effect does a specific/unit tax have on the supply curve
causes a parallel shift in supply curve
What is an Ad Valorem Tax
is a percentage tax
e.g. 20% on unit price
What affect does an Ad Valorem tax have on the supply curve
causes a pivot shift
i.e. non-parallel shift in supply curve
If co-efficient of price of demand >1
Price is …..
and most of the indirect tax will be
elastic
tax will be absorbed by the supplier
If co-efficient of price of demand <1
PED is …..
most of an indirect tax
inelastic
tax can be passed on to the consumer
describe a graph for a tax implemented of elastic demand
describe a graph for tax implemented on inelastic demand
Describe a graph, when tax is implemented on perfectly inelastic demand
All of the tax is paid by the consumer
Describe the graph for perfectly elastic supply
All of the tax is paid by the consumer
Give 2 examples of Ad Valorem tax
VAT
Insurance premium Tax
Describe the movement for the supply curve of an Ad Valorem
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
Give example of subsidies
Biofuel subsidies for farmers
Solar panel “Feed-in Tariffs”
Apprenticeship schemes
Aid to businesses making losses
Childcare for working families
Subsidies for public transport
What is a subsidy
any form of Government support, offered to producers
It does not have to be repaid
How does a subsidy paid to a producer, affect the supply curve and market equilibrium
causes an outward shift of the supply curve
leading to a lower equilibrium price and increase in quantity traded
How much do the producer and consumer pay individually, when a subsidy is added
P1 -P3 = Producer
P1 - P2 = Consumer
Reasons for Subsides
- 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
Reasons against subsidies
- 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
How will demand being inelastic affect subsidies
The subsidy has a larger effect on equilibrium price
How will demand being elastic affect subsidies
Subsidy has a stronger effect on equilibrium quantity
Reasons for Taxations
- 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
Reasons against taxations
- 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
What is a Maximum price
This is a legally imposed maximum price in a market that suppliers cannot exceed
To be effective a Maximum must …
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
For Maximum price to work, you need excess demand
the amount of excess demand depends on …
Price elasticity of demand
Price elasticity of supply
Describe a S&D diagram for Max price
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.
What are the benefits of Maximum price
- 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
What are 6 limitations of maximum price
- 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
What is a minimum price
Is a price-floor, which is legally imposed, which the normal market price cannot fall below
An example of a minimum price
minimum wage
Unit price in Scotland of alcohol
A minimum price is an attempt to
reduce demand
For minimum price to work it must …
be set above free-market equilibrium, so it will reduce demand and increase supply, leading to excess supply
What must the government do, for minimum price to work
Government might buy excess supply at fixed prices
What will impact the effectiveness of a minimum price
Price elasticity of supply
Price elasticity of demand
Describe a graph for minimum price
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
Describe benefits for Minimum price
- Reduces social externalities of over-consumption of demerit goods
- Businesses would benefit from higher revenue
- Protects businesses in theory
Describe drawbacks for minimum price
- 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
