Government Intervention Flashcards
What do governments use indirect tax for?
To affect the supply of some goods/services
What are the two types of indirect tax?
Specific tax & Ad Valorem tax
What is a specific tax?
A fixed amount that is charged per unit of a particular good, no matter what the price of the good is
What is an Ad Valorem tax?
Taxes that are charged as a proportion of the price of a good
What is the effect of indirect tax on producers?
They increase their costs, causing the supply curve to shift left
What goods do governments normally put indirect taxes on?
Goods that have negative externalities
What is the aim of taxation on negative externalities?
To internalise the externality, the additional tax creates revenue for the government, they can use this money to offset the effects of the good
What does the amount of tax passed on to the consumer depend on?
The PED of the good, if the good is inelastic most of the extra cost will be passed on to the consumer, if it is elastic most of the extra cost will be absorbed by the producer
What are the advantages of taxation?
The costs of negative externalities is internalised
If the demand for the good doesn’t reduce, there is still benefit that the revenue gained by the government can be used to offset externalities
What are the disadvantages of taxation?
It can be difficult to put a monetary value on the cost of the negative externalities
Demand for the good will not be reduced if the good is price inelastic
Firms may choose to relocate to avoid the indirect tax, which would mean they would not be paying tax anymore
The money from the taxes may not be spent on internalising the externality
What is a subsidy?
Money paid to producers by the government to encourage the production and consumption of goods and services with positive externalities
What are the advantages of subsidies?
The benefit of goods with positive externalities is internalised, the cost of the externality is covered by the government subsidy
Subsidies can change preferences
Positive externalities are still present
Subsidies can support a domestic industry until it can exploit economies of scale and become internationally competitive
What are the disadvantages of subsidies?
It is difficult to put a monetary value on the benefit of the positive externalities
Subsidies have an opportunity cost
Producers may become reliant on the subsidies
Effectiveness of subsidies depends on elasticity of demand
What are price controls?
A limit set by the government on a good or service
Why does the government set maximum prices on goods and services?
To increase consumption of a merit good, or to make a necessity more affordable
