Micro 12 - Government Intervention in markets 2: Indirect taxation and subsidies Flashcards
What is meant by internalising an externality?
Internalising an externality makes the external costs part of the price mechanism
What is a subsidy?
A subsidy is money paid by the government to the producer of a good to make it cheaper than it would be otherwise
Why may governments provide a subsidy?
Governments sometimes provide subsidies to encourage demand for a good
What is an indirect tax?
An indirect tax is a tax placed on a good by the government to reduce the demand for it as the presence of a tax on the good aims to discourage people from buying it as the tax raises its market price
What is the relationship between taxes and subsidies and supply curves?
Taxes and subsidies lead to shifts in the supply curves of goods/services which cause prices to change. The changes in price lead to an extension or contraction in demand
Who is the benefit of subsidies received by?
The benefit of subsidies is received partly by the producer and partly by the consumer
How do subsidies affect markets?
Subsidies encourage increased production and a fall in price, which leads to an increase in demand. So a subsidy shifts the supply curve to the right
What are the amounts of the subsidy gained by producers and consumers dependent on?
The producer gain and consumer gain is dependent on the price elasticities of demand and supply
What is the cost to the government of a subsidy equal to?
The cost to the government of a subsidy is equal to the consumer gain + the producer gain
What area on a diagram is indicated by the consumer gain of a subsidy?
The consumer gain is rectangle represented by the fall in price from the original equilibrium price to the new lower price after the subsidy has been introduced
Why is the consumer gain on a diagram represented by the by the difference between the equilibrium and lower price after a subsidy?
As consumers gain by paying less for the good than they would have if there was no subsidy
What area on a diagram is indicated by the producer gain of a subsidy?
The producer gain is the rectangle represented by the difference between the maximum price consumers are willing and able to pay and the original equilibrium price
Why is the producer gain on a diagram represented by the difference between the maximum price consumers are willing and able to pay and the original equilibrium price?
As producers gain by receiving extra revenue from the government that they can keep
Is the consumer gain from a subsidy greater when the demand curve is more price elastic or inelastic?
The consumer gain is greater when the demand curve is more price inelastic
Is the producer gain from a subsidy greater when the demand curve is more price elastic or inelastic?
The producer gain is greater when the demand curve is more price elastic
What effect do indirect taxes have on a market?
Taxes increase the price of a good which leads to a reduction in demand. Taxation shifts the supply curve to the left
Who is the burden of taxes received by?
The burden of a tax is imposed both on consumers and producers
What is the proportion of the burden incurred from a tax on producers and consumers dependent on?
The proportion of the burden from a tax incurred on consumers and producers depends on the price elasticities of demand and supply
What is the revenue received by the government from a tax equal to?
The consumer burden + the producer burden
On a diagram showing a subsidy where do the consumer and producer gain rectangles end at in terms of their length?
At the new equilibrium quantity after the subsidy. (Q2)
On a diagram showing a tax where do the consumer and producer burden rectangles end at in terms of their length?
At the new equilibrium quantity after the subsidy. (Q2)
On a diagram showing a subsidy which one of the two rectangles are the consumer and producer gain?
- The top rectangle is the producer gain
- The bottom rectangle is the consumer gain
On a diagram showing an indirect tax which one of the two rectangles are the consumer and producer burden?
- The top rectangle is the consumer burden
- The bottom rectangle is the producer burden
On a diagram what is the area represented by the consumer burden of a tax?
The consumer burden is represented by the rise in price from the original equilibrium price to the new higher price after the tax
On a diagram why is the consumer burden on a tax represented by the rectangle between the equilibrium price and the new price after the tax?
As consumers lose out by paying more for the good than if the tax wasn’t in place
On a diagram what is the area represented by the producer burden of a tax?
The producer burden is represented by the difference between the equilibrium price and the minimum price producers are willing and able to supply at
On a diagram why is the producer burden on a tax represented by the rectangle between the equilibrium price and the minimum price suppliers are willing to supply at?
As producers lose out by some of the revenue to the government
Is the consumer burden from a tax greater when the demand curve is more price elastic or inelastic?
The consumer burden of a tax is greater when the demand curve is more price inelastic
Is the producer burden from a tax greater when the demand curve is more price elastic or inelastic?
The producer burden of a tax is greater when the demand curve is more price elastic
Draw two diagrams showing a subsidy on a good with price elastic and inelastic demand
See page 30 in revision guide
Draw two diagrams showing a tax on a good with price elastic and inelastic demand
See page 31 in revision guide
What are the two types of indirect tax?
- Specific taxes
- Ad valorem taxes
What are specific taxes?
Specific taxes are a fixed amount that’s charged per unit of a particular good no matter what the price of that good is
What are ad valorem taxes?
Ad valorem taxes are charged as a proportion of the price of a good
What direct taxes?
Direct taxes are imposed on individuals or organisations
Do the two types of indirect taxes affect supply curves in the same or different ways?
Different ways
How does a specific tax affect a supply curve?
A specific tax causes a parallel shift of the supply curve. The tax is the same fixed amount at a low price and a high price
How does an Ad valorem tax affect a supply curve?
An Ad valorem tax causes a non-parallel shift of the supply curve with the biggest impact being on higher price goods. The tax is a smaller amount at a low price compared to a high price
Which goods do governments often put indirect taxes on?
Governments often put indirect taxes on goods that have negative externalities
What is the aim of an indirect tax being imposed on a good with negative externalities?
The aim of this taxation is to internalise the externality that the good produces i.e. make the producer and/or consumer of the product cover the cost of its externalities
What can the revenue received by the government from a tax on a good be used for?
The revenue made by the government from taxes can be used to offset the effect of the externalities
What is the tax per unit on a diagram equal to?
The distance between the two supply curves
How can the government revenue from a diagram be calculated?
Tax per unit * number of units sold
What will the amount of tax passed on to the consumer depend on?
The price elasticity of demand
What are the advantages of indirect taxes?
- The cost of the negative externalities is internalised in the price of the good which may reduce demand for a good and the level of its production reducing the effects of the negative externalities
- If demand isn’t reduced, there’s still the benefit that the revenue gained from the tax can be used by the government to offset the externaliites
What are the disadvantages of indirect taxes?
- It can be difficult to put a monetary value on the cost of the negative externalities
- For goods where demand is price inelastic the demand isn’t reduced by the extra cost of the tax
- Indirect taxes usually increase the cost of production which reduces a product’s international competitiveness
- Firms may choose to relocate and sell their goods abroad to avoid the indirect taxation. This would remove their contributions to the economy such as payment of tax and the provision of employment
How may governments use subsidies?
The government may pay subsidies with the aim of encouraging the production and consumption of goods and services with positive externalities
What does the proportion of a subsidy given to producers and consumers depend on?
The proportion of a subsidy given to producers and consumers depends on the elasticity of the supply and demand curves
What are the advantages of subsidies?
- The benefit of goods with positive externalities is internalised i.e. the cost of these externalities is covered by the government subsidy, so the price of the goods is reduced from what it would be in the absence of the subsidy
- Subsidies can change preferences - producers will supply goods with positive externalities and consumers will consume them and receive the benefits from them
- The positive externalities are still present
- Subsidies can support a domestic industry until it grows to the point that it can exploit economies of scale and become internationally competitive
What are the disadvantages of subsidies?
- It can be difficult to put a monetary value on the benefit of the positive externalities
- Any subsidy has an opportunity cost
- Subsidies may make producers inefficient and reliant on subsidies. The subsidy means that producers have less incentive to reduce costs or innovate
- The effectiveness of subsidies depends on the elasticity of demand
- The subsidised goods and services may not be as good as those they’re aiming to replace
