taxes and subsidies

two types of taxes

indirect and direct

Indirect taxes definition

Indirect taxes are imposed by the government on consumption.

Examples of indirect tax

VAT, sales tax, import duties

When are indirect taxes used?

Used to reduce the consumption of demerit goods.

How do advanced economies reduce the consumption of demerit goods?

VAT, special taxes or duties levied on specific goods.

Definition of direct tax + example

Direct taxes are taxes levied directly on income, wealth or capital of individuals and firms.personal income tax, corporation tax, capital tax

what is direct tax based on

Based on the ability to pay principle. Higher income earners pay higher percentages.

Tax incidence definition

Incidence of tax refers to who bears the burden of the tax between producers and consumers.Consumers often take the burden

Normal incidence definition

Who is legally responsible to pay the tax.

Effective incidence

Who actually experiences the financial burden.

If tax is imposed, where does supply go?

Supply shifts left, and is called S1+tax.

where is burden on consumers

above

where is the burden on producers

below

Interpretation of indirect tax

Due to the imposition of indirect tax on _____ as the government intends to reduce the consumption of ______ thus the price of the product has increased, hence the consumer and producer tax burden area is _____ and government gain area is _____.

Advantages of indirect tax

Reduces the consumption of demerit goods.. In the long run, health of workforce will increase.

Disadvantages of indirect tax

Increase prices leads to rising consumer and producer tax burden.

If demand is inelastic, what happens to the tax incidence?

When demand is inelastic, the % change in QD is smaller than % change in price meaning consumers are less responsive to price changes. Hence when indirect tax is imposed, producers are able to pass on a large proportion of tax to consumers in the form of higher prices. Therefore the economic burden falls heavily on consumers leading to higher consumer burden.

If demand is elastic, what happens to tax incidence?

When demand is elastic, the % change in QD is larger than % change in price meaning consumers are highly responsive to changes in price. Hence, when indirect taxes are imposed, a significant increase in price leads to a proportionally larger decrease in QD. This makes it difficult for producers to pass the full tax burden onto consumers since it results in a substantial loss in revenue. The tax incidence will fall more heavily on producers since they would absorb a greater proportion of tax for greater revenue.

definition of subsidies

A subsidy is a grant or amount of financial aid given by the government to reduce producers costs of production to encourage production.

purpose of subsidies

To lower production costs, To increase output, To promote merit goods

interpretation of subsidies

The government has given out subsidies to ____ thus reducing their cost of production, hence reducing the price of the product where consumer and producer gain is ______, and ___ is government loss.

what is the area of consumer gain

below

what is the area of producer gain

above