5. Indirect taxes, subsidies and price controls

Question 1

define inderect tax

Answer 1

INDERECT TAX: tax imposed on expenditure

Question 2

How tax affects supply curve

Answer 2

Shifts it upwards BY THE SIZE of the tax - less products will be supplied at every price

Question 3

Types of indirect taxes

Answer 3

1. Specific tax: fixed tax that is imposed per unit no matter the price
2. Percentage tax (ad valorem tax): tax is a percentage of the selling price - shift os S increases as price of goods increases

Question 4

An indirect tax is imposed, what are the effects on consumers, producers, gov and market

Answer 4

Revenue/tax burden changes

PRODUCERS: revenue decreases

GOV: tax revenue increases

CONSUMERS: tax burden increases

THE MARKET: harmed

Tax burden shared equally between consumers and producers

Question 5

On which elasticity is common to place taxes

Answer 5

Price inelastic - anyways will be demanded - demand not affected (cigarettes, alcohol)

Question 6

Define subsidy

Answer 6

SUBSIDY: an amount of money paid by the government to a firm per unit of output

Question 7

Reasons for giving subsidies

Answer 7

1. To lower price of essential goods - increase consumption of them
2. To ensure supply of goods which gov thinks are necessary for economy (food, power supply, water, industry creating much employment)
3. To enable domestic producers compete with overseas trade - protectionism

Question 8

How supply curve shifts when subsidy imposed

Answer 8

Shifts DOWN BY THE SIZE of the subsidy - more supplied at every price

Question 9

Subsidy effects on consumers, producers, gov and market

Answer 9

Revenue/expenditure

PRODUCER: increase in revenue

CONSUMER: decrease in expenditure

GOV: increase in expenditure

Market - benefits from gov support

Question 10

Costs of giving a subsidy

Answer 10

• opportunity cost to alternative spending areas
• firms will be more inefficient - worse resource allocation
• taxpayers are funding the subsidy
• harms to other countries’ imports
• may lead to over-production - wasting resources
• may lead to dumping - major issue

Question 11

Types of price controls

Answer 11

1. Price ceiling - max price set by gov
2. Price floors - min price set by gov

Question 12

Reasons for price ceiling

Answer 12

Gov sets a max price below equilibrium to:

• protect consumers where the product is necessary/merit good: on food during food shortage

Question 13

Problems with price ceiling

Answer 13

Excess demand is created - black market/queues in shops - not fair for consumers - gov must interfere:

1. decrease demand
2. increase supply: offer subsidies to producers, gov start producing themselves, release stocks if stored the product

=> new equilibrium - market balanced

Question 14

Define price ceiling

Answer 14

PRICE CEILING: maximum price set by the gov for which particular goods can be sold

Question 15

Define price floor

Answer 15

PRICE FLOOR: minimum price set by the gov for a product under which it can be sold in the market

Question 16

Why gov setst price floors

Answer 16

1. Raise incomes for producers who are important to the economy
2. To protect workers by setting minimum wage

Question 17

Problems with price floors

Answer 17

Excess supply - producers try to sell for lower price - to maintain min price - gov must interfere:

1buy the excess supply to increase demand - new equilibrium - the surplus can be stored/destroyed/sold abroad - accusations of dumping might emerge

Question 18

Other ways besides price control how minimum price can be maintained

Answer 18

1. Producers can be limited by quotas
2. Gov could icrease demand for goods by advertising, restricting import - protectionsit policies -> might lead to inefficiency and waste of resources