Theme 1 - Winter Term 1 Yr 12

Question 1

What is tax? (Firms and government)

Answer 1

Firms: A financial contribution paid to the government by consumers and businesses.
Government: The way in which governments are able to raise revenues for common expenditure.

Question 2

What are subsidies?

Answer 2

Governments incentives to encourage the production or consumption of a certain product or service.

Question 3

Examples of direct and indirect taxes.

Answer 3

Direct: income tax, corporation tax, inheritance tax, national insurance.
Indirect (consumption taxes are usually tax): VAT (standard rate of 20%), custom duty (tariffs), excise duties (tariffs), on tobacco duties (£3.76 + 17%)/alcohol duties (beer tax = 41.5 per unit)

Question 4

Examples of subsidies.

Answer 4

Child benefits 
Free school meals
Free museums 
Free healthcare
Farming
Scholarships

Question 5

What are taxes used for?

Answer 5

Subsidies, defence, education, benefits, maintenance of public goods, NHS, buying imports, monarchy, police, pensions, international aid, government/Parliament, council housing/spending, bailout of another country, reduce consumption on products.

Question 6

Do you use a tax, subsidy or both?

Answer 6

Raise revenue for services - Tax
Control demand - mainly tax but also subsidy
Change spending habits - mainly tax but also subsidy
Make domestic firms more competitive - both
Make sure we continue to produce and consume essentials - subsidy

Question 7

What does an indirect tax do?

Answer 7

It is tax imposed by the government that increases the supply cost faced by producers.
It is always shown by the vertical distance between the two supply SUPPLY curves. Due to the tax, less can be supplied at each price level, resulting in an increase in market price and a contraction in demand, since there is a new equilibrium output.

Question 8

What is the incidence of tax?

Answer 8

An increase in tax either increases the burden on the consumer or seller. To compensate for this 1/3 things can happen to cover the burden:

1) The consumer picks up the burden through an increase in price. Usually the ‘incidence of tax’ falls on consumer due to if the good is very price inelastic (cigarettes) or if the supply is more elastic.
2) The seller absorbs the burden with a decrease in profits. Where supply is inelastic or demand elastic the ‘incidence of tax’ will fall on the producer.
3) They share the burden - both seller and consumer

Question 9

How does ‘incidence of tax’ work for subsidies?

Answer 9

The point of subsidies are to get suppliers to lower the price of their product. If the product is elastic producers may on,y have to pass a small part of the subsidy to get the desired effect. If demand is inelastic, it must pay more of the saving.

Question 10

What are the arguments when assessing indirect taxes?

Answer 10

• Effect of tax depends in part on coefficient of elasticity of demand
• Problems in setting the tax rate at the right level to achieve aims - are there any unintended consequences?
• Does an indirect tax generate substancial tax revenues?
• How is the tax revenue used - perhaps in a particular project?
• What is the impact on businesses - might there be a loss of jobs or capital investment?
• What is the impact on competition - will an indirect tax negatively affect competitiveness and trade?
• who are the main winners and losers?
• does a tax have a regressive effect on lower income groups, increasing the gap in income?

Question 11

What is a public good?

Answer 11

A good that possesses the characteristics of non-rivalry and non-excludability.

Question 12

Define non-rivalry in consumption.

Answer 12

Consumption from one economic agent does not reduce the amount available to others.

Question 13

Define non-excludability.

Answer 13

Once provided, any economic agent cannot be prevented from using it.

Question 14

Why are public goods an example of market failure?

Answer 14

M.F also happens when consumers use too much of a product that is bad for them and the economy in general, or they are not suing enough of a product that is good for them and the economy. There are many reasons why this happens, but the government usually will have to get involved to sort it out.

• Public goods are a ‘missing market’ and are not provided by a free market.
• Public goods can on,y be provided collectively.
• In a mixed economy, governments tend to provide public goods to correct market failure.

Question 15

Define quasi-public goods.

Answer 15

Quasi-public goods possess some of the characteristics of public goods for some, but not all the time.

Question 16

Examples of public goods.

Answer 16

Street lighting
Public art
Street cleaning
National defence

Question 17

Examples of private goods.

Answer 17

Trains
Private gyms
Exclusive clubs
Tickets to an event
Meals in a restaurant

Question 18

Examples of quasi-public goods.

Answer 18

Park benches

Crowded beaches

Question 19

Examples of private and public goods.

Answer 19

Healthcare

Education

Question 20

What is the free-rider problem? (Associates with non-rivalry)

Answer 20

Public goods are NOT always free!
Consumers usually pay for public goods through tax, which the government then uses to provide public goods.
However, because anyone can use the, you cannot stop someone who has not paid for the public good from using it - which is the free-rider problem.
Also, who will check?

Question 21

What are externalities?

Answer 21

Externalities (or over-spill effects) arise when private costs + benefits are different to social costs + benefits.
They occur when the activities of producers + consumers have unintended effects on third parties.
Examples:
- smoking can cause cancer but that is not its intention
- pollution caused by cutting down trees is not intended

Question 22

What are the 3 aspects of externalities and define them?

Answer 22

• Private cost is the cost to the consumer and firm internal to the exchange.
• Private benefit is the benefit to the consumer and firms internal to the exchange.
• External cost is the negative, unintended spillover effects to 3rd parties.
• External benefit is the positive, unintended spillover effects to 3rd parties.
• Social cost is the cost to the whole society (P.C + E.C)
• Social benefit is the benefit to the who,e society. (P.B + E.B)

Question 23

Why does a negative externality happens?

Answer 23

Occurs when S.C exceeds P.C.

Question 24

Why does a positive externality happen?

Answer 24

Occurs when S.B exceeds P.B.

Question 25

What are the characteristics of a merit good?

Answer 25

1) People don’t understand the true personal benefit. E.g. museums, education or vaccinations.
2) Usually have a positive externality.

Question 26

What are the characteristics of demerit goods?

Answer 26

1) A good that harms the consumer. E.g. when people don’t realise or ignore the costs of doing something like smoking or recreational drugs.
- Smoking can have a regressive effect on others around them.
2) Usually have negative externality.

Question 27

What is a negative externality?

Answer 27

Negative externalities occur when production and/or consumption impose EXTERNAL COSTS TO THIRD PARTIES outside of the market for which no appropriate compensation is paid.

Question 28

What are negative production externalities? + examples

Answer 28

The spillover costs generated and received in the production of goods and services.
These include:
- Air pollution from factories
- Pollution from fertilisers
- Industrial waste
- Noise pollution e.g. planes
- Collapsing fish stocks
- Methane emissions

Question 29

What are negative consumption externalities? + examples

Answer 29

The spillover costs generated and receive in the consumption of goods and services.
These include:
- Vehicles pollution 
- Household waste
- Traffic congestion 
- Gambling addiction
- Noise pollution from neighbours 
- Air pollution from smokers
- Litter from tourists
- Spillover costs from obesity

Question 30

What should you consider when answering questions on negative externalities?

Answer 30

Whether the external costs are significant and if so, whether they can be measured and valued accurately.

Question 31

Draw a negative externality graph.

Answer 31

Demand curve: MPB=MSB
Supply curve: since MSC>MPC, the S1 curve is above the S2 curve
Price on y-axis and Output on x-axis.
(The free market diagram assumes that there are no external costs of benefit)

Question 32

What are the advantages of pollution tax?

Answer 32

• Internalises the externality, therefore makes the polluter pay.
• Utilises the price mechanism to change incentives and choice like reduce pollution
• Raises tax revenue which might then be used to address other market failures (e.g. public goods and indirect taxes)

Question 33

What are the disadvantages of pollution tax?

Answer 33

• Low price elasticity of demand, therefore tax may not change the behaviour of the economic agents.
• Risks of tax evasion (illegal) and tax avoidance (legal)
• Can hit Lower income families most + which can cause social unrest (putting tariffs on cars coming in from abroad which can also can other countries to put tariffs up on UK products, but this causes social unrest in the north - not pollution)

Question 34

Why reduce externalities (with using pollution tax)?

Answer 34

• Imposing a tax - known as “making the polluter pay’
• Taxes increase the MPC causing a fall in demand
• Some economists argue that revenue creaste by taxes should be ‘ring-fenced’ and allocated to projects that protect/enhance the environment. E.g. money raised from congestion charge could go towards improving mass transport services
• revenue from higher taxes on cigarettes can fund better healthcare programmes

Question 35

Evaluate the impact of industrial regulations.

Answer 35

For:
- Regulations act as a spur for business innovation like cutting carbon emissions
- can be more effect is demand is unresponsive to price changes e.g if it is inelastic
- can be gradually toughened each year, helping stimulate capital investment
Against:
- high cost of enforcement/administration of regulations
- can lead to unwelcome unintended consequences/Government failure like the housing market
- the cost of meeting regulation can discourage small businesses and lower competition in markets

Question 36

Why can taxes lead to government failure?

Answer 36

1) Assigning the right level of taxation: there are problems with setting the right tax so that the private costs will exactly equate with the social cost.
2) Consumer welfare effects: if demand is inelastic then producers can put the tax on the consumer, therefore the tax may have had little effect. Taxes on some demerit goods can have a regressive effect on lower-income consumer, therefore widening the inequality of distribution of income.
3) Employment and investment consequences: if taxes are raised in one country then another country can shift production to a different country with lower taxes. This WILL NOT reduce global pollution and create problems like structural unemployment and a loss of international competitiveness, worsening the trade balance.

Question 37

How can negative externalities be reduced?

Answer 37

Tax
Regulations
Education

Question 38

What is a positive externality?

Answer 38

P.E create external benefits to 3rd parties.

Question 39

What is imperfect information?

Answer 39

Where consumers are not aware of the full costs of benefits of using a good or service.

Question 40

What does a government subsidy do?

Answer 40

• Designed to reduce the PC of consumption or reduce the cost of supply.
• Lower costs should cause an expansion of demand
• counter: there will be a cost to the state in the short term.