taxes and subsidies econ quiz

why are taxes imposed?

raise revenue for providing public services and goods

pure public goods

nonrival in provision and non excludable in consumption

non rival goods

do not diminish in quantity or quality as more people use them

non excludable goods

costly or nearly impossible to exclude one use from using the good

private goods

rival, excludable, examples: ice cream, cheese, houses, cars

common resources

non excludable, rival, examples: fresh water, fish, timber, pasture

club goods

excludable, non rival, examples: cable television, cinemas, wifi, tollroads

public goods

non excludable, non rival, examples: fresh air, knowledge, national defense

2 ways government can impose tax

producers (decreases supply by the amount of tax, producers face added cost), consumers (decreases demand by the amount of tax, price rises for the good in question)

consequences of tax

tax creates a wedge between price paid by buyers and the price received by sellers, taxes reduce output and create deadweight losses (there is inefficiency caused by taxation), both producers and consumers are made worse off, incidence of taxes depend on elasticities of demand and supply

tax incidence and elasticity

the less elastic demand and supply, the smaller the deadweight loss, and vice versa (so, if goal is to raise revenue, tax things in inelastic supply or demand), if your goal is to discourage an activity, the tax will not be very effective if demand or supply is highly inelastic, whichever between demand and supply is more inelastic/elastic, bears greater/lesser burden of the tax

definition of subsidy

negative of taxes: sellers/buyers get paid for production/consumption, the subsidy pushes either the demand curve outwards or the supply curve outwards

results of subsidies

who receives the subsidy does not matter (the benefits are shared by both consumers and producers), who benefits more depends on relative elasticities, subsidies create inefficiencies

DWL in taxes and subsidies

tax: some beneficial trades did not occur because Qt < Q*, subsidy: some non beneficial trades occur and hence Qs > Q*, whoever bears the greater burden of the tax enjoys the larger benefits in case of subsidy

when demand is inelastic and supply is elastic

increase in Ps < decrease in Pc, consumers gain more than sellers in terms of price, consumers (inelastic) enjoy more benefits of subsidy

when demand is elastic and supply is inelastic

increase in Ps > decrease in Pc, producers gain more than consumers in terms of price, producers (inelastic) enjoy more benefits of subsidy