methods and effects of government intervention in markets chapter 13 Flashcards
types of indirect tax
ad valorem tax and specific taxes
ad valorem tax
taxes in proportion or percentage of the price charged by the retailer. like VAT or GST
specific tax
in the form of a fixed amount per unit purchased. tax is based on measurable quantity. the final price includes tax
why are indirect taxes used
Indirect taxes are widely used to discourage the production and consumption of demerit goods. These taxes tend to be passed on to consumers through increased prices in the market, although technically they are imposed on the producer.
who should pay indirect tax
this tax must be paid to the government by retailers, wholesalers, manufacturers and other providers of taxable goods and services.
impact of indirect tax on goods
a business requires a price that is higher than the original price by the amount of the tax. With a specific tax, this is represented by a shift to the left of the supply curve by the amount of the tax. the quantity is traded less
incidence
the extent to which the tax burden is borne by the producer or the consumer or both
how does price elasticity of demand affect tax
The extent to which the producer is able to pass on the tax by raising price depends on the price elasticity of demand for the product. The more price inelastic the demand, the easier it is for the seller to pass on the tax to the consumer in the form of higher prices.
how does price inelastic demand affect tax
The more price inelastic the demand, the easier it is for the seller to pass on the tax to the consumer in the form of higher prices.
how does price elastic demand affect tax
If demand is price elastic, then consumers will invariably buy less of the product as price rises, resulting in the producer having to absorb a greater part of the indirect tax.
how does indirect taxes impact collection of tax
it is easier to collect indirect tax
subsidiaries
direct payments made by the governments to the producers of goods and services
some reasons for subsidiaries
to keep down the market prices of essential goods
to encourage greater consumption of merit goods
to raise producers income
how does subsidiaries impact producers
it has the opposite effect of indirect tax- it is the equivalent of fall in costs for the producer. there will be a fall in price and increase in quantity traded
how are subsidiaries shown in graphs
subsidiaries results in right ward shift in the market supply curve. a reduction in a subsidy payment shifts the supply curve to the left
who shares the incidence of indirect taxes
When supply is more elastic than demand, the tax burden falls on the buyers. If demand is more elastic than supply, producers will bear the cost of the tax
who shares the incidence of subsidy
the incidence of a subsidy is shared between consumers and producers. consumers benefit through lower price. producers benefit through receiving a higher price than they would selling an increased supply on the market
disadvantages of subsidies
it interferes with the market mechanism.
it has implications for opportunity cost
subsidy payments usually come out of tax revenue where there will be other conflicting demands for funding
problems of subsidy
Estimating the size of subsidy required is a further difficulty.
subsidies are ‘blanket’ or lump sum payments and, unlike taxes on consumers, cannot easily be linked to incomes and the ability to pay so high income and low income consumers pay the same amount per unit of what they consume.
how to overcome problems of subsidy
it is necessary to assess who benefits from a particular subsidy
how are free services provided by the government financed
financed through the tax system
how do free services provided by the government lower equality
If these services are used equally by all citizens, then those on lowest incomes gain most as a percentage of their income
how are goods and services provided by the government that do not make it free
A common model is for there to be part free provision, with other parts being paid for at the point of use.
why do market failure not justify free provision to the consumer
The justification must be on the grounds of equity. The view is that everyone should have access to a certain level of healthcare and education regardless of income. This means that where these services are provided universally free, they are the same as universal benefits.
characteristics of public goods
they will not be provided by the market mechanism. Neither will consumers be willing to pay for them.
provided directly by the government and paid for out of tax revenue.
what are public goods frequently criticized for
it leads to inefficiency, with costs higher than what would have been the case in a competitive market.
goods and services of different economies
There are major differences in the direct provision of goods and services between economies
disadvantages with direct provision of goods and services
Resources are not allocated efficiently. If a charge is made or introduced, demand is likely to fall. It can also be argued that many consumers could afford to pay a charge, so reducing the tax burden or allowing the funding saved in this way to be put to alternative uses.
direct provision of goods and services
measure used to correct market failures caused by public goods
maximum price
a price that is fixed; the market price must not exceed this price; sometimes called price ceiling
what can prompt the government to pass legislation to impose a maximum price
Market failure can occur where the price of a good in the free market is too high.
how does maximum price help
This is seen as a way of assisting families on low incomes, reducing inequalities in income or in recognition that the wider benefits of consuming a particular product are not fully appreciated.
where are maximum price controls valid
in markets where the maximum price imposed is below the normal equilibrium price as determined in a free market. This means that the price that can be legally charged by sellers must not be any higher.
problem with maximum prices
as the price cannot rise, the available supply has to be allocated in some other way.
ways of restricting demand
queuing and rationing
problem with rationing
leads to an informal or underground market for the products involved, with consumers then having to pay inflated prices well above the maximum price. Such markets inevitably arise when there are dissatisfied people who have not been able to buy the goods they want because not enough has been produced.
minimum price
a price that is fixed; the market price must not go below this price; sometimes called a price floor. not common as those where maximum price control is imposed
why governments may impose minimum price control
Controls are only valid in markets where the minimum price is set above the normal equilibrium price.
examples of minimum price control
wages in certain occupations, usually low skilled, to avoid employers exploiting their employees
certain types of imported goods where close substitutes produced by domestic producers are available.
effect at minimum price
suppliers are willing to supply considerably more products demanded by consumers. a lower quantity is traded than would have occurred at the equilibrium price
disadvantages of minimum price
that producers are likely to be inefficient; firms with high costs have little incentive to reduce costs since the high minimum price protects them from lower cost competitors.
there is a danger that an informal market will develop,
The high rate of indirect taxation and high minimum price mean these products are attractive for non-market trading.
Consumers will be more than happy to buy from dealers offering these goods at less than the regulated minimum price.
buffer stock scheme
a type of commodity agreement designed to limit price fluctuations
how do buffer stock scheme work
smooth price rises and falls by buying and selling stocks of products depending on market conditions. buffer stock schemes combine the principles of minimum and maximum price controls.
buffer stock scheme at minimum price
starts by setting a minimum price for a particular product. If the market price looks like going below this minimum, the buffer stock scheme will buy up stocks. These will be stored in warehouses. This action should raise the price since supply in the market has fallen.
buffer stock scheme at maximum price
The effect will be to increase supplies which in time will see a reduction in the price of the product.
why should the government use information provision as a form of direct intervention
information failure can result in the under consumption of merit goods and the over consumption of demerit goods
examples of information provision as a form of direct intervention
public health announcements and campaigns
nutrition and allergy information on food packaging.
compulsory information on cigarette packets warning of the dangers of smoking
