1.3 Government intervention Flashcards
What are indirect taxes?
Indirect taxes are taxes imposed on spending to buy goods and services. They are paid partly by consumers but are paid to the government by producers (firms).
What are excise taxes?
Taxes imposed on particular goods and services such as petrol, cigarettes and alcohol - usually to influence the consumption of these goods.
What are sales taxes?
Taxes on all (or most) goods and services (VAT)
What are the two types of indirect taxes?
(applicability)
- Excise taxes
- Sales taxes
What are the two types of indirect (excise) taxes?
(method of taxation)
- Specific taxes
- Ad valorem taxes
What are direct taxes and how do they differ from indirect taxes?
Direct taxes are taxes paid directly by the taxpayer, indirect are not.
How do excise taxes affect the allocation of resources?
As excise taxes increase the price paid by consumers, they would reduce their spending on such goods.
Excise taxes also lower the price received by producers, causing them to produce less.
So by changing prices signals and incentives, excise taxes affect the allocation of resources.
This may either increase or decrease allocate efficiency depending on the situation prior to the tax.
Why might a government impose indirect (excise) taxes?
(4)
- Excise taxes are a source of government revenue.
- Excise taxes are a method to discourage consumption of a good that may be harmful - ‘vice’ or ‘sin’ taxes.
- Excise taxes can be used to redistribute income.
- Excise taxes are a method to improve the allocation of resources (reduce allocative inefficiencies) by correcting negative externalities.
What are specific taxes?
A fixed amount of tax per unit of the good or service sold e.g. $5 per packet of cigarettes.
What are ad valorem taxes?
A fixed percentage of the price of the good or service is taxed.
How can you diagrammatically show:
a) a specific tax
b) an ad valorem tax
Both are leftward shifts of supply.
a) it is constant so the supply curve just moves upwards by the tax per unit
b) as it is a percentage, the tax per unit increases each time, so, the gradient of the supply curve increases
How can you diagrammatically show the impact on the market of imposing:
a) a direct tax
b) an ad valorem tax
P* and Q* are original market equilibrium positions.
Pc and Qt are where the “new” supply intersects demand.
Pp is the price at Qt on the original supply curve.
What are the market impacts of imposing an indirect tax?
(7)
- Equilibrium quantity produced and consumed falls from Q* to Qt
- Equilibrium price paid by consumers increases from P* to Pc
- Consumer expenditure changes from (P* x Q*) to (Pc x Qt )
- Price received by the firm falls from (P* to Pp), which is (Pc - tax per unit)
- The firm’s revenue falls from P* x Q* to Pp x Qt
- The government receives a tax revenue of (tax per unit x Qt) or (Pc - Pp x Qt)
- Underallocation of resources as Qt is below the market equilibrium of Q*
What consequences would an indirect tax have on:
- Consumers
- Producers
- The government
- Workers
- Society as a whole
Consumers: Lose out. They pay a higher price, for less of a good.
Producers: Lose out. They receive a lower price, for less of the good - revenue decreases.
The government: Gains. They receive more revenue, good for the government budget and achieving policy aims.
Workers: Lose out. Less output means fewer workers required which may lead to redundancies and unemployment.
Society: Loses out. Underallocation of resources.
What is a welfare loss (deadweight loss)?
The welfare benefits that are lost to society due to resources not being allocated efficiently.
How can you diagrammatically show an indirect tax’s impact on consumer, producer and social surplus?
Consumer surplus decreases.
Producer surplus decreases.
Government revenue increases.
Social surplus decreases, therefore a welfare loss of a + b is created.
What is tax incidence?
The burden of the tax.
Who faces a greater tax incidence when demand is inelastic?
Diagram?
Consumers
Who faces a greater tax incidence when demand is elastic?
Diagram?
Producers
Who faces a greater tax incidence when supply is inelastic?
Diagram?
Producers
Who faces a greater tax incidence when supply is elastic?
Diagram?
Consumers
How can you diagrammatically show a subsidy being imposed?
How can you diagrammatically show the impacts on the market?
Subsidies increase supply, so the supply curve shifts down by the value of subsidy per unit.
P* and Q* are original market equilibrium positions.
Pc and Qsb are where the “new” supply intersects demand.
Pp is the price at Qsb on the original supply curve.
How can you diagrammatically show the impact of a subsidy on consumer, producer and social surplus?
There is a gain in producer surplus.
There is a gain in consumer surplus.
There is a welfare loss created at a.
How would you diagrammatically show a price ceiling (maximum price)?
A price line that is below the market equilibrium.
What consequences can price ceilings have on consumers, producers, workers, the government, society as a whole?
Diagram?
Consumers: Partly gain, partly lose. Consumers who are willing and able to buy ar a lower price are better off. However, due to shortages, not all demanders can be supplied to.
Producers: Lose out. Price ceilings limit their price and quantity supplied - reducing revenue.
Workers: Lose out. A fall in quantity supplied means that fewer workers are required for output, therefore some are made redundant and unemployment increases.
The government: No financial benefit or loss. Potentially some political gain for those that agree with the decision, but a backlash from those that disagree, or those left behind.
Society: Loses out. Deadweight loss created.
How would you diagrammatically present a price floor?
A price line above market equilibrium.
How can you diagrammatically show the impact of a price floor and the different surpluses?
Consumer surplus (a+b+c → a)
Producer surplus (d+e → b+d)
Welfare loss of c+e
