Chapt 3 (Taxes & subsidies) Elasticity To A Govt Flashcards
When may a govt intervene in a market
- of free market cannot allocate resources efficiently
OR
- To ensure fair allocation of resources
Summary of ways govt can intervene in the market
- Indirect taxes
- Subsidies
- Price controls (price ceiling & price floor)
Objective of indirect taxes
- To reduce consumption / production of that good or service that is deemed undesirable
AND - To raise govt revenue
What is an indirect tax / What is indirect tax taxing?
- Taxes on goods or services
- taxes paid by consumers to Govt indirectly through the producers
What is a direct tax / What is is taxing?
- Direct tax is a tax on consumer income
- Tax paid directly to govt by consumer
Describe 2 Diff types of indirect tax, and their graphs
What tax to assume if NOT STATED?
-
Specific tax
- Taxes a fixed price per unit of a good
**Eg: $0.20 per litre of petrol
__
GRAPH:
- Parallel shift upwards
______________ -
Ad Valorem tax
- Taxes a fixed percentage of the total sales price of a good
*^Eg: GST is 9%**
GRAPH:
- Non-parallel shift upwards
___________________
- If tax not stated, assume specific tax
Effects of indirect specific tax on Equi Price and Quantity ** PED >1**
- Equil price rises (bcuz good is more expensive)
- equil quantity falls (bcuz less ppl wanted more expensive taxed good)
____________________
PED > 1 demand price elastic - Consumers more responsive to changes in price
- __small Rise in price__ due to tax lead to more than proportionate fall in quantity demanded
___
Compared to PED <1,
PED>1 will: - have price rise less
- Have quantity fall way more
- TE by consumer falls
- TR for producers ALWAYS falls no matter PED value
__ - Less ppl want good
- Objective of tax is to reduce consumption of a good
- Tax is more effective when demand price elastic
Effects of indirect specific tax on Equi Price and Quantity ** PED <1**
- Equil price rises (bcuz good is more expensive)
- equil quantity falls (bcuz less ppl wanted more expensive taxed good)
____________________
PED < 1 demand price inelastic - Consumers less responsive to changes in price
- __LARGE Rise in price__ due to tax lead to less than proportionate fall in quantity demanded
___
Compared to PED > 1,
PED < 1 will: - have price rise more
- Have quantity fall way less
- TE by consumer rises
- TR by producer ALWAYS falls no matter PED value
____
Effectiveness: - Less ppl want good
- Objective of tax is to reduce consumption of a good
- Tax is less effective when demand price Inelastic
Effect of indirect specific tax on TR and TE
After taxes,
TE and TR are different
__________________________
TE by consumers
__method:
DRAW GRAPH with/
- leftward shift if supply curve due to specific tax
- 1 demand curve when PED >1
- 1 demand curve when PED <1
ALL 3 curves must intersect at E0
________THEORY
- if PED > 1, rise in price leads to more than proportionate fall in QD, so TE falls
- if PED <1 rise in price leads to less than proportionate fall in QD, so TE rises
__________________________
TR for producers
(Post-tax revenue)
- ALWAYS falls
___
TE > TR
(Tax paid by CONSUMERS)
- TE = TR + Tax revenue gained by govt (sum of loss of CS and PS)
What is allocative efficiency, total surplus and societal welfare?
Allocative efficiency is a state of the market that performs efficiently by producing what is aligned with preferences of consumers and producers.
- Occurs when marginal benefit = marginal cost
- allocative efficiency causes total surplus to be max
- Thus societal welfare is also max
Define CS and PS.
Effect of indirect specific tax on allocative efficiency?
CS: Diff between the price a consumer is willing and able to pay for a good and the actual price paid
PS: The diff between the price a producer is willing and able and the actual price received for the good
________________________________
- Specific tax reduces CS and PS
- Loss of CS and PS become govt’s gained tax revenue
- Indirect tax results in loss of societal welfare aka deadweight loss
- In the graph, it is the triangle
Define deadweight loss
Deadweight loss is the loss of societal welfare when a socially optimal level of output is not reached
Objective of Subsidies
- encourage consumption/production of a good or service
- To raise revenue/income of producers of essential goods
- Increase affordability of essential goods to lower income
Define subsidy
Subsidies are an amount of money given to producers by the govt for each unit of good sold
Effect of subsidy on COP & supply curve, and price
- Artificially lowers COP
- So supply rises, supply curve shifts downward
- Producer may pass on benefit on subsidy to consumers by lowering price
Effects of subsides on Equi Price & Quantity, TE & TR** PED >1**.
Is the subsidy effective?
PED is elastic
- small fall in price from subsidy
- enough for more than proportionate rise in QD
___
- Leads to rise in TE of consumers
- TR of producers ALWAYS rise regardless of PED
-
TR > TE
(Subsidies lower producers’ COP) -
TR = TE + subsidy pay out lost from govt (Gain in CS and PS)
___ - 1 purpose of subsidy is to encourage consumption
- Subsidy is more effective in *increasing consumption**
Effects of subsides on Equi Price & Quantity, TE & TR PED <1
Is the subsidy effective?
PED Inelastic
- large fall in price due to subsidy
- Leads to less than proportionate rise in QD
- Fall in TE of consumers
- TR ALWAYS rise regardless of PeD
____
TR > TE
(Subsidies lower producers COP) -
TR = TE + subsidy pay out from govt (gain in CS and PS)
____ - 1 purpose of subsidy is to keep essential goods affordable
- Subsidy is more effective in keeping essential goods affordable
Effect of subsidy on allocative efficiency (TS, CS PS)
- Subsidy leads to allocative inefficiency
- Loss of govt expenditure in terms of subsidy pay out is greater than combined gain in CS and PS
- So deadweight loss
- In the graph, it is the triangle outside CS and PS
