1.2.9 + 1.2.10

Question 1

What is an indirect tax?

Answer 1

tax imposed by the government that increases the supply costs faced by producers

Question 2

how is tax shown on a diagram?

Answer 2

amount of the tax is always shown by the vertical distance between the two supply curves.

Question 3

what does the impact of the tax on demand depend on?

Answer 3

depends on the price elasticity of demand,

- demand curve does not shift!

Question 4

who will indirect tax be passed onto depending on elasticity of demand

Answer 4

• indirect tax on suppliers will have no effect on market price if demand is perfectly elastic
• An indirect tax on suppliers will be passed onto consumers in full if demand is perfectly price inelastic
• An indirect tax on suppliers will be passed onto suppliers in full if supply is perfectly elastic

Question 5

specific tax

Answer 5

is a set tax per unit e.g. a £5 tax per unit– this causes a parallel shift in the supply curve
- tax is same fixed amount at all prices
Eg, fuel duty and beer duty

Question 6

ad valorem tax

Answer 6

a percentage tax e.g. 20% on the unit price – this causes a pivot shift in the
supply curve

eg. VAT, import tariffs

Question 7

If co-efficient of price elasticity of demand >1 for tax

elastic

Answer 7

most of an indirect tax will be absorbed by the supplier

I.e lower incidence of tax on consumers

Question 8

If co-efficient of price elasticity of demand <1 for tax

inelastic

Answer 8

most of an indirect tax can be passed on to the consumer

I.e higher incidence of tax on consumers

Question 9

Perfectly inelastic demand on tax

Answer 9

All of the tax is paid by the consumer

Question 10

Perfectly elastic demand on tax

Answer 10

All of the tax is paid by the producer

Question 11

What is a subsidy?

Answer 11

subsidy is any form of government support

• cause outward shift in supply curve (as they reduce costs of production), and lower market price and expansion of quantity demanded

Question 12

Economic and social justifications for a subsidy

Answer 12

• Helping poorer families with food, child-care costs
• Encourage output and investment in fledgling sectors such as renewable energy.
• Protect jobs in loss-making industries hit by recession such as steel and farming
• Make key health care treatments affordable to families on lower incomes.

Question 13

subsidy effect on inelastic demand

Answer 13

• small change in demand of good as it is inelastic
• firm does not see significant rise in revenue so no reason to increase output
• consumers however benefit due to fall in price
• most of benefit thus lies with consumers as they can better maximise utility

Question 14

subsidy effect on elastic demand

Answer 14

• demand significantly increases as good is elastic and price reduces
• firm sees significant rise in revenue
• high change in output but small change in price
• most of gain lies with firms

Question 15

why may an agent act in an irrational way?

Answer 15

• bounded rationality
• influenced by others (herd mentality, peer pressure)
• emotion overtakes logic
• desire for instant rewards (hyperbolic discounting)
• habitual behaviour/ consumer inertia

Question 16

Habitual behaviour, why?

Answer 16

• Repeat choices / purchases often become automatic because default choices don’t involve mental effort

Question 17

Bounded rationality caused by (3)

Answer 17

• not sufficient information
• ability to process information
• time available

Question 18

Bounded control

Answer 18

desire for instant and immediate gratification and a reluctance to hold back for longer term rewards

Question 19

hyperbolic discounting

Answer 19

we value the present much more than the future

Question 20

Anchoring

Answer 20

Value is often set by anchors or imprints in our minds we use as mental reference points.

Question 21

Priming

Answer 21

Control our behaviour by cues that work subconsciously and prime us to behave and choose in certain ways

• eg, subliminal advertising