1.2.9 Indirect Taxes and Subsidies

Question 1

Define indirect tax

Answer 1

Indirect taxes are taxes on expenditure

Question 2

Give 2 examples of indirect taxes

Answer 2

Specific Tax and Ad Valorem tax

Question 3

What happens to producer incidence if demand is elastic and VAT increases?

Answer 3

The burden falls mainly on the producer. This is because consumers in this market will not accept a price rise, this means price will not rise a lot following the tax increase. However tax is essential so the producer must pay.

Question 4

What happens to consumer incidence if demand is inelastic and VAT increases?

Answer 4

If demand is inelastic, producers pass most of the tax onto the consumer so the incidence of taxation on consumers will increase. This is because producers will know that consumers will not change the buying habits significantly with the change of price caused by tax, meaning they are able to pass on the tax.

Question 5

Define subsidy

Answer 5

A subsidy is a form of government aid (mainly payment) that aims to reduce costs of production

Question 6

How are consumers affected by a subsidy?

Answer 6

Consumers benefit because price falls so their is an increase in consumer surplus

Question 7

How are producers affected by a subsidy?

Answer 7

The cost of production decreases meaning they are able to increase their output.

Question 8

How is the government affected by a subsidy?

Answer 8

Subsidies cost the government because although they only give them to a firm/industry that will benefit society, and henceforth achieve their own goals, expenditure must fall elsewhere in order for the government to be able to afford these subsidies.