THEME 1 - Topic 5 - The Price Mechanism in Action Flashcards
Define an indirect tax
Is a tax levied on expenditure on goods/services. Examples of VAT and excise duty
Define a specific tax
A tax placed on a good/service which is a fixed amount per unit. Example of excise duty on alcohol and drugs.
Define an ad valorem tax
A tax which is a percentage on the price of a good/service. Example of VAT levied at 20%.
Define incidence of tax
The way in which the burden of paying a sales tax is divided between buyers and sellers.
What’s the incidence of tax if the good is price inelastic in demand?
Consumers pay more of the burden than producers, because the producer passes on the tax in the form of higher prices because consumers are not too sensitive.
What’s the incidence of tax if the good is price elastic in demand?
Producers pay more of the burden than consumers, because consumers are very sensitive to a change in price.
When a specific tax is levied on a good, what represents the burden to the producer on a diagram?
Original price and the lower price (p-p2).
When a specific tax is levied on a good, what represents the burden to the consumer on a diagram?
Original price and the higher price (p1-p).
What represents the tax per unit?
The distance between the 2 supply curves.
Define a subsidy
A payment given by the government to producers to encourage the production of a good/service, by lowering their costs of production.
Define the incidence of subsidy
Is the way in which the benefits of a subsidy given to the producer are distributed to themselves and the consumer.
When a subsidy is granted to a firm, what represents the incidence of subsidy to the producer on a diagram?
The original price and the higher price (p2-p).
When a subsidy is granted to a firm, what represents the incidence of subsidy to the consumers on a diagram?
The original price and the lower price (p-p1).
What represents the subsidy per unit?
The distance between the 2 supply curves.
Define irrational behaviour
When a consumers doesn’t choose to maximise their utility, including habitual behaviour, information overload, suffering from inertia.
