9 - Government Intervention, Part 2 Flashcards
Reason for indirect taxes
- Generally to generate government revenue
- Imcreases cost of production, reflected on the price
- Include VAT, the excise tax on tobacco, alcohol, petrol
Types of indirect taxes
- Specific Tax
- Ad valorem tax
What is a specific tax (indirect tax)
Indirect tax on a good levied at a certain amount per unit of good, irrespective of price
- Fixed amount for each unit of a good or service sold, such as cents per kilogram
What is a Ad valorem tax (indirect tax)
Indirect tax of a percentage of price of good (VAT)
- E.g. VAT is charged at 20% in the UK. A 20% ad valorem tax increases production costs by 20% at each level of output
How would you see specific tax and ad valorem tax on a graph
Specific tax is parallel to the supply curve
Ad valorem tax is a diagonal line from the origin (where the supply curve starts) and goes above the supply curve (not parallel)
What would Tax do to a supply curve
Shift supply curve upwards (left)
What type of tax is an excise tax
A specific tax
What happens to price and quantity when tax is imposed
Price increases, quantity decreases (new equilibrium) when supply curve shifts up
Tax is directly paid by who and indirectly paid by who
Directly paid by suppliers, indirectly paid by consumers as price increases
What’s an excise tax
Amount paid by either the consumer or producer per unit of good at the point of sale
What happens to consumer and producer surplus when tax is imposed
They both decrease as consumers now pay a price above equilibrium price and producers receive a price lower than equilibrium
What is a tax wedge
Difference between what consumers take, and what producers receive
What’s incidence of tax
Measure of the effect of a tax on the prices consumers pay and sellers receive in a market
Formula for sellers (producers) share of the tax
P* - (P2 - Tax) / Tax
Formula for consumers (Buyers) share of the tax
P* - P2 / Tax
What does incidence of tax depend on
Elasticity of Demand of the good and the supply of the good
When demand curve is inelastic who is the incidence of tax carried by
Carried by consumers
- Because customers are less responsive by change in price as this could be due to no substitutes. Therefore, when price increases due to tax, customers just pay it as they have no choice of substitute
When demand curve is elastic who is the incidence of tax carried by
Carried by producers
- This is because consumers have substitutes to change to therefore are responsive to changes in price, therefore suppliers will have to pay for the tax directly; will not be able to pass it on to consumers
When supply curve is elastic who is the incidence of tax carried by
Carried by consumers IF supply curve is elastic
- Because when supply is perfectly elastic it means elasticity of supply is infinite
- Meaning, producers are willing to supply anywhere above the equilibrium price but nothing below
- Therefore, producers can pass on burden of tax to consumers as price is above equilibrium
When supply curve is inelastic who is the incidence of tax carried by
Burden is carried by producers
- Perfectly inelastic supply means elasticity of supply is 0
- Quantity of supply is fixed even if price increases, therefore supply cannot move much if not at all therefore producers carry the incidence of tax
What are subsidies
Sum of money granted by the government
- Negative taxes
What will subsidies cause price and quantity to do
Subsidies will cause market price to fall and quantity to increase
Cost of subsidy to government depends on 2 things…
- Size of the per unit paid by the government (size of subsidy)
- Equilibrium Quantity after subsidy is introduced (produce more, better for government)
What happens to consumer and producer surplus when there’s a subsidy
They both increase
- When Tax happens they both decrease (subsidy and taxes are polar opposites)
Is there a deadweight loss when a subsidy is given
Yes however can be recovered through tax
Advantages of subsidies
- Creates Low price, high quantity - This helps low income families
- Help create jobs, as to produce more, will need more input (labour)
- Help control inflation
Disadvantages of subsidies
- Subsidy money is used to improve production, however could be used for something else (Opportunity cost, as could spend this money on education, healthcare etc)
