Pack 12 Flashcards
Define the term Indirect Tax
A tax usually imposed on the purchase of goods and services. It represents a tax on expenditure.
Explain how taxes work to correct market failure caused by negative externalities
The tax increases costs of production so it reduces incentives to produce. This causes supply curve to shift left and the price rises from P1 to P2, causing a contraction in demand so consumption is reduced from Q1 to Q2.
Outline benefits of using a tax to correct market failure
-Taxes raise money for the government which can be used to help third parties affected by external costs (hypothecation).
-Polluter pays principle. Polluters pay the tax which is used to help internalise the external costs.
Outline drawbacks of using a tax to correct market failures
-Indirect taxes cause a fall in consumer and producer surplus.
-Indirect taxes are regressive as they take a large portion of those on lower incomes.
-Unintended consequences may occur when people try to get around the tax by smuggling.
Identify 4 industries in which a subsidy might be used
-Biofuel subsidies for farmers
-Solar Panel feed-in tariffs
-Child care for working families
-Subsidies to the rail industry
Subsidy diagrams
•Supply shifts right
•Consumer gain at the bottom
•Producer gain at the top
Effect of PED on subsidys
Relatively elastic demand:
•firms absorb a lot of the subsidy as costs need to be paid off to put up with lower demand
Relatively inelastic demand:
•most subsidy goes towards consumers but only a small change in quantity demanded
3 pros and 3 cons of a subsidy
Benefits:
- Subsidies increase output in an industry.
- Subsidies can lower production costs, increasing incentives to produce.
- Subsidies can keep industries that the government wants to protect.
Drawbacks:
- Subsidies are expensive to the government.
- If demand is inelastic, subsidy wont have as much of an impact.
- It is difficult to put a monetary value on external benefits so size of the subsidy can be hard.
Explain, step-by-step, how a subsidy affects a market and may affect market failure
Often goods with positive externalities are subsidised as greater incentive to produce leads to more firms which leads to more benefits.
Define specific and ad-valorem tax
Specific tax - charged as a fixed amount per unit of a good, the tax does not vary with the price of the product.
Ad-valorem tax - charged as a percentage of the price of a good.
Tax diagrams
•Supply shifts left from s1 to s1+tax
•Consumer burden at the top
•Producer burden at the bottom
•Size of the tax per unit is represented by vertical distance between both supply curves
•Incidence of tax = tax area paid by consumers and producers
Effect of PED on taxes
Relatively inelastic demand:
•Consumers burden a large proportion of the tax
Relatively elastic demand:
•Producers burden a large proportion of the tax
