Taxes and Subsidies

What are the two types of tax (give examples of both)

Direct tax - corporation, income tax

Indirect tax - VAT, sugar, plastic bag charge

Draw a specific indirect tax onto a diagram

parallel inward shift of the supply curve

What are the different types of indirect taxes

specific indirect

Ad-valorem

What is a direct tax

imposed directly on your income

What is a indirect tax

imposed on things you purchase rather than straight onto your income

What is a specific indirect tax

this is a set tax per unit e.g. 10p per plastic bag

each additional unit purchased the price increases by the same amount each time

What is an Ad-Valorem tax

This is a percentage tax on the unit price e.g. 20% VAT

increases by the same proportional amount each time

Draw an Ad-valorem tax onto a diagram

pivotal inward shift of supply

How does the addition of a specific tax affect demand

causes it to contract as the supply curve moves inwards

Draw and label a specific tax diagram labelling:

• consumer burden

• producer burden

• consumer surplus

• tax revenue

• producer surplus

• DWL

CS from new supply line to equilibrium

CS and CB on the top

What are the welfare implications of a specific tax

CS reduces

PS reduces

creates a DWL

Why is there a DWL when a tax is added

The gain in government revenue (CB+PB) is less than the loss in consumer and producer surplus, meaning there is a DWL

CS + PS > CB + PB = DWL

How can you calculate the DWL

(CS + PS) - gain in gov.t revenue = DWL

What are the features of inelastic demand in terms of a tax diagram

• less effective a specific tax is in reducing the market equilibrium quantity

• the more effective it is in raising the equilibrium price

• the consumer burden is larger than the producer burden

• the more revenue is received by the government

  • DWL is lower

Why is the consumer burden larger than the producer burden on a relatively inelastic tax diagram, illustrate this on a diagram

As the producer knows that an increase in the price of the product will not change demand that much. Therefore, they pass on the majority of the burden to the consumer

What is a sin tax

taxes placed on products which are harmful to us or the environment, in an attempt to deter us from buying them e.g. cigarettes

Why do sin taxes benefit the gov.t

as they are placed on products with relatively inelastic demand (addictive/necessity0

So the tax doesn’t reduce the equilibrium quantity as people keep purchasing them

price level increases a lot so the gov.t receives lots of tax revenue

Define a subsidy

A government grant given to producers to lower their cost of production

What are subsidies given towards

research and development of new technologies

training workers

Draw and label a subsidy diagram

What are the two key differences of a subsidy diagram to a tax diagram

1. subsidies are good for consumers and producers so are benefits not burdens

2. the benefit rectangle for consumers is below producers

Why is there a DWL when a subsidy is added

the gain in consumer and producer surplus is smaller than the cost of the subsidy to the gov.t

What are the key features of a inelastic demand curve on a subsidy diagram

• the less effective a subsidy is in increasing the market equilibrium quantity

• the more effective a subsidy is in decreasing the equilibrium price

• the consumer benefit is larger than the producer benefit

• DWL is lower