1.3.4.4 indirect taxes & subsidies

Question 1

indirect taxes

Answer 1

taxes on expenditure, paid to the government by producers

Question 2

specific tax

Answer 2

the tax is the same for each unit of the good transacted, regardless of its price

Question 3

ad valorem tax

Answer 3

the tax imposed is a percentage tax. the tax charged increases as a proportion to the value of the tax base.
as the price of the good increases, the actual amount of tax paid per unit increases

Question 4

benefits of indirect taxes

Answer 4

1. tax revenue
   - government can use the tax revenue to provide better public goods
2. discourages consumption
   - the tax raises the cost, making the price likely higher
3. producers would reallocate resources
   - reduce resources spent on a taxed product
   - shift it to more beneficial products
4. redistribute income (tax certain goods)
   - taxing luxury goods

Question 5

impact of tax

Answer 5

reduces supply:
- sellers of the good will want to charge more
- at every quantity, the seller will only be willing and able to produce that unit if the price increases by an amount that covers the tax to reflect the increase in costs

shifts the supply curve vertically by the amount of the specific tax
- supply curves are parallel for specific tax
- supply curves pivot for ad valorem tax

Question 6

effect of tax on price and quantity

Answer 6

demand is not affected
supply decreases

Question 7

effect of tax on consumer expenditure

Answer 7

if demand is elastic: decrease
if demand is inelastic: increase

Question 8

effect of tax on producer revenue

Answer 8

producer revenue decreases

Question 9

effect of tax on consumer surplus

Answer 9

consumer surplus is less
- they are paying more and consuming less

Question 10

effect of tax on producer surplus

Answer 10

producer surplus is less
- they are receiving less and producing ess

Question 11

consequences of indirect taxes on stakeholders

Answer 11

consumers: pay a higher price and receiving less of the good —> worse off
producers: fall in the price they receive & quantity they sell —> worse off
government: gains revenues from the taxation, positive for their budget (administrative costs might be high)
workers: lower amount of output means fewer workers are needed —> worse off, they may become unemployed
society: worse off, under allocation of resources to the production of the good

Question 12

which side bears a larger tax incidence when PED > PES

Answer 12

demand more elastic, supply more inelastic
—> producer bear more tax burden

Question 13

which side bears a larger tax incidence when PED < PES

Answer 13

supply more elastic, demand more inelastic
-> producer bear more tax burden

Question 14

in order to maximise government taxation revenue, what should the government do?

Answer 14

tax a product with inelastic demand
—> consumers would still pay for it

Question 15

subsidies

Answer 15

financial assistance by the government to individual or groups of individuals such as firms, consumers and industries

Question 16

benefits of subsidies

Answer 16

1. increases the quantity of production and consumption
   - lower cost of production, producers can choose to share it
   —> if they share, then the price would decrease and the demand would increase
2. increases revenue for producers
   - government gives the money directly
3. can help low-income groups afford necessities
   - reduces inequality
4. can help certain industries that are deemed desirable to an economy
5. financial injection into the economy
   - a type of government investment, can create jobs

Question 17

impact of subsidy

Answer 17

increases supply: for each price, the firm is willing to supply more output at any given qty supplied
demand is unchanged
equilibrium price falls
equilibrium quantity increases
producer revenue increases
government spending increases

Question 18

effect of subsidy on consumer expenditure

Answer 18

if demand is elastic: consumer expenditure increases
if demand is inelastic: consumer expenditure decreases

Question 19

effect of subsidy on producer revenue

Answer 19

producer revenue increases

Question 20

effect of subsidy on government

Answer 20

subsidy is a burden to the budget of governments

Question 21

effect of subsidy on workers

Answer 21

output expands, firms are likely to hire more workers
—> more job opportunities

Question 22

effect of subsidy on society

Answer 22

overallocation of resources to the production of the goods
allocative inefficiency
higher price for producers may protect inefficient firms

Question 23

effect of subsidy on consumer surplus

Answer 23

consumer surplus increases
- they are paying less and consuming more

Question 24

effect of subsidy on producer surplus

Answer 24

producer surplus increases
- they are receiving more and producing more

Question 25

which side benefits the most from a subsidy when PED > PES?

Answer 25

supply is more elastic, demand less elastic
- consumers

Question 26

which side benefits the most from a subsidy when PED > PES?

Answer 26

demand more elastic, supply less elastic
- producers