1.2.9 Indirect Taxes and Subsidies

Question 1

What are indirect taxes?

Answer 1

• A tax on expenditure where the person who is ultimately charged the tax is not the person responsible for paying the sum to the government.
• The business is required to pay the tax but the customer is charged instead

Question 2

What are the two types of indirect taxes?

Answer 2

• Ad Valorem tax
• Specific tax

Question 3

What is Ad Valorem tax?

Answer 3

• Where the tax payable increases in proportion to the value of the good
• The tax is a percentage of the cost of the good

Question 4

Give an example of Ad Valorem tax

Answer 4

VAT

Question 5

What is specific tax?

Answer 5

• Where an amount is added to the price
• The tax increases with the amount bought rather than the value of goods

Question 6

Give an example of a specific tax

Answer 6

Excise duties on alcohol, tobacco and petrol

Question 7

What causes supply to shift from S1 to S2?

Answer 7

The introduction of tax causes supply to shift because it leads to an increase in the cost of production.

Question 8

What is the knock on effect after the shift from S1 to S2?

Answer 8

• Leads to a rise in price from P1 to P2
• A fall in output from Q1 to Q2

Question 9

What do the consumers see?

Answer 9

• Higher prices and suffers from a tax burden of the orange area

Question 10

What do the Producers see?

Answer 10

• A rise in costs and a fall in output, suffering from the tax burden of the grey area

Question 11

What is the government tax revenue?

Answer 11

Area of shaded areas (ABxQ2)

Question 12

What is the size of the tax?

Answer 12

The vertical distance between S1 and S2, shown by the line AB

Question 13

Shown is an ad valorem tax diagram.

What’s the difference between a specific and Ad Valorem tax diagram?

Answer 13

• The effects are the same but the supply curve shifts and tilts
• This is so that the hap between S1 and S2 grows

Question 14

Why does the gap between S1 and S2 grow?

Answer 14

• Because its an Ad Valorem tax
• The tax is a percentage of the value
• When the price is small, the tax will only be a small amount but when the price is high, the tax will be a large amount

Question 15

What is the incidence of tax?

Answer 15

The tax burden on the taxpayer

Question 16

What happens if the demand curve is perfectly elastic?

Answer 16

• The supplier will pay all the tax

Question 17

What happens if the supply curve is perfectly inelastic?

Answer 17

• The supplier will pay all the tax

Question 18

What happens if the demand curve is perfectly inelastic?

Answer 18

• All the tax will be passed on to the consumer

Question 19

What happens if the supply curve is perfectly elastic?

Answer 19

• All the tax will be passed on to the consumer

Question 20

In general, the more elastic the demand curve, or the more inelastic the supply curve….

Answer 20

The lower the incidence of tax on the consumer (meaning the supplier has to pay more)

Question 21

Ceteris Paribus, the more inelastic the demand curve…

Answer 21

• The higher the tax revenue for the government because quantity demanded falls less and the more goods that are bought, the higher the tax revenue

Question 22

What is a subsidy?

Answer 22

A grant given by the government and is the opposite of a tax.

Question 23

What is the reason for a subsidy?

Answer 23

To encourage production/consumption of a good or service

Question 24

Give examples of subsidies occurring.

Answer 24

• Given to necessities, e.g. bread
• Companies employing disadvantaged workers
• Those manufacturing in the UK to keep them competitive with imported goods

Question 25

What causes supply to shift from S1 to S2?

Answer 25

The producer sees a fall in production costs due to the subsidy

Question 26

What is the knock on effect after the shift from S1 to S2?

Answer 26

• There is a rise in output from Q1 to Q2
• A fall in price from P1 to P2

Question 27

What is the consumer subsidy?

Answer 27

Orange box

Question 28

What is the producer subsidy?

Answer 28

Grey Box

Question 29

What is the producer subsidy?

Answer 29

Grey Box

Question 30

What is the government spending?

Answer 30

• The total shaded area (ABxQ2)