1.2.9 Indirect taxes and subsidies (copy)

ad valorem tax

tax levied as a percentage of the value of the good e.g. VAT 20% of an item

specific tax

tax levied on volume or weight e.g. sugar tax

who taxation affects

it is levied on suppliers

ad valorem tax diagram

specific tax diagram

impact of the introduction of a tax

causes supply curve to shift upwards from s to s1 because it leads to an increase in the cost of production, this will cause a rise in price from p to p1 and a fall in output from q to q1

the size of the tax is shown by...

...the vertical difference between supply curves

if the demand curve (PED) is perfectly elastic or supply curve (PES) is perfectly inelastic

the supplier will pay all the tax

the demand curve (PED) is perfectly inelastic or supply curve (PES) is perfectly elastic

all the tax will be passed on to the consumer

benefit to gov: ceteris paribus, the more inelastic the demand curve

the higher revenue of tax because quantity demanded falls less than the increase in price

impact of indirect tax on consumers

-higher price -lower choice -lower quality -people seek alternatives -regressive - low income households hit hardest

impact of indirect tax on firms

-increase in the cost of production -lower output -reduced profits -> lower producer surplus -potential job losses -potential bankruptcy

impact of indirect tax on governments

-increase in inflation -reduced consumer confidence -reduction in damage to environment/health -price protests -increased tax revenues

subsidy

a form of government support - financial or otherwise - to encourage supply of a good/service

subsidy diagram

inelastic market demand subsidy

fall in price will have a smaller increase in demand

elastic market demand subsidy

fall in price will have a larger increase in demand

main issue with subsidies

the opportunity cost

why subsidies are greatly supported

increases both consumer and producer surplus and the cost of subsidies get spread across many taxpayers so a limited cost for the government

impact of subsidy on consumers

-lower price -more choice -better quality -greater consumption of merit goods

impact of subsidy on firms

-reduced production costs -increased competitiveness -increased output -greater revenue and profits -protection of jobs -prevent bankruptcy -more investment in capital

impact of subsidy on governments

-opportunity cost of subsidy -greater consumption of merit goods -greater tax revenues from increased consumption -downwards pressure on inflation -lower unemployment rate -greater dependency could make firms dependent and inefficient