Theme 1.4 Flashcards
What are indirect taxes?
Taxes on expenditure that increase production costs for producers
They discourage the production or consumption of demerit goods.
How do indirect taxes affect market price and demand?
They increase market price and contract demand
This is due to the higher costs passed on to consumers.
What is the effect of an indirect tax equal to the external cost?
The supply curve becomes MSC rather than MPC, leading to a socially optimum equilibrium
This internalizes the externality.
Define a subsidy.
A payment from the government to a producer to lower production costs
It encourages producers to produce more.
What is the purpose of subsidies?
To encourage the consumption of merit goods
They internalize external benefits in the market price.
What are some disadvantages of subsidies?
- Opportunity cost to the government
- Potential higher taxes
- Firms may become inefficient
- Government failure with less efficient industries
These can lead to misallocation of resources.
What is a maximum price?
A government-set price to encourage consumption or production of a good
It must be set below the free market price to be effective.
What are potential effects of setting a maximum price?
- Welfare gains for consumers
- Increased efficiency in firms
- Reduced profits for firms
Firms may raise prices of other goods as a result.
What is a minimum price?
A government-set price to discourage consumption or production of a good
It prevents the price from falling below a certain level.
What is the purpose of minimum prices?
To reduce negative externalities from consuming demerit goods
Example: Alcohol consumption.
What are tradeable pollution permits?
Permits that limit pollution created by industries and can be traded
Firms can buy and sell allowances between themselves.
What are advantages of tradeable pollution permits?
- Benefits the environment by encouraging green production
- Government revenue from permit sales
- Raises revenue for greener firms
This encourages investment in green technology.
What are disadvantages of tradeable pollution permits?
- Firms may relocate to avoid limits
- Higher costs may be passed to consumers
- Expensive for governments to monitor emissions
This can lead to inefficiencies.
What is regulation in the context of government policy?
Laws that ban consumers from consuming certain goods or enforce obligations
Non-compliance can lead to heavy fines for firms.
What are some disadvantages of regulation?
- Difficult to police
- High administrative costs
- Possible black market consumption
- Increased costs for firms
Firms may pass these costs onto consumers.
