Indirect Taxes and Subsidies

Question 1

What is an indirect tax?

Answer 1

A tax on expenditure.

Question 2

What are the two types indirect tax?

Answer 2

1) Specific/unit tax.
2) Ad valorem tax.

Question 3

What is an ad valorem tax?

Answer 3

A tax that increases in proportion to the value of a good/service.

Question 4

What is an example of an ad valorem tax?

Answer 4

VAT - e.g. 20% on most goods/services in the UK.

Question 5

What is a specific/unit tax?

Answer 5

A tax that does not change with the value of the goods, but with the amount or volume of the good.

Question 6

What is an example of a specific/unit tax?

Answer 6

Excise duties - e.g. 45p per pint of beer.

Question 7

What is meant by the imposition of a tax?

Answer 7

The cost of a tax.

Question 8

What effect will the imposition/increase in the rate of an indirect tax have on the supply curve?

Answer 8

A shift upwards and to the left of the supply curve.

Question 9

What are the impacts of indirect taxes on consumers?

Answer 9

An indirect tax will raise the price of goods and services, so consumers will have to pay a higher price (the tax burden).

Question 10

Why do governments impose indirect taxes (3)?

Answer 10

Governments will impose indirect taxes to raise income, for social services and to cover the negative externalities caused by an industry or a good/service.

Question 11

What is the impact
of indirect taxes on producers?

Answer 11

As indirect taxes rise, so will costs of production. Producers will try to pass on a proportion of this tax incidence through higher prices. This could lower some firms competitiveness and could result in the loss of jobs.

Question 12

How is the value of tax calculated?

Answer 12

Value of tax = difference between the old and new supply curve.

Question 13

How is the incidence of tax on consumers calculated?

Answer 13

Incidence on consumers = difference between the old and new equilibrium prices.

Question 14

How is the incidence of tax on producers calculated?

Answer 14

Incidence on producers = value of tax - incidence on consumers.

Question 15

What is a subsidy?

Answer 15

A grant from the government to encourage the production or consumption of a particular good or service.

Question 16

What is an input subsidy?

Answer 16

A subsidy used to reduce the costs of input used in production. E.g. an apprenticeship scheme will reduce the cost of labour.

Question 17

What affect will subsidies have on the supply curve?

Answer 17

A subsidy will increase supply, as production costs fall. The supply curve will shift downwards and to the right.

Question 18

What impact do subsidies have on consumers?

Answer 18

The introduction of a subsidy will reduce the price paid for a given good/service, increasing the utility of each unit consumed. The proportion of the subsidy received by the consumer is dependent on the PED of the good/service.

Question 19

What impacts do subsidies have on governments?

Answer 19

Initially, the introduction of a subsidy is a cost to the government. However, in the long run, the subsidy will bring benefits to the economy, like the increased consumption of a desirable good/service, greater welfare to society, improved competitiveness and increased job security.

Question 20

What impacts do subsidies have on producers?

Answer 20

The introduction of a subsidy will lower costs of production, increasing output and helping firms to profit and grow. The proportion of the subsidy retained by producers is dependent on the PED of the good/service.

Question 21

If PED is inelastic, who pays the tax incidence and by how much?

Answer 21

Mostly paid by consumers.

Question 22

If PES is inelastic, who pays the tax incidence and by how much?

Answer 22

Most paid by producers.

Question 23

If PED is unitary, who pays the tax incidence and by how much?

Answer 23

Both producers and consumers pay an equal amount.

Question 24

If PES is unitary, who pays the tax incidence and by how much?

Answer 24

Both producers and consumers pay an equal amount.

Question 25

If PED is elastic, who pays the tax incidence and by how much?

Answer 25

Mostly paid by producers.

Question 26

If PES is elastic, who pays the tax incidence and by how much?

Answer 26

Mostly paid by consumers.

Question 27

If PED is perfectly elastic, who pays the tax incidence and by how much?

Answer 27

Wholly paid by producers.

Question 28

If PES is perfectly elastic, who pays the tax incidence and by how much?

Answer 28

Wholly paid by consumers.

Question 29

If PED is perfectly inelastic, who pays the tax incidence and by how much?

Answer 29

Wholly paid by consumers.

Question 30

If PES is perfectly inelastic, who pays the tax incidence and by how much?

Answer 30

Wholly paid by producers.

Question 31

If PED is inelastic, who benefits the most from a subsidy?

Answer 31

Most benefit passed on to consumers through a fall in price.

Question 32

If PES is inelastic, who benefits the most from a subsidy?

Answer 32

Most benefit passed on to producers as there is little price change.

Question 33

If PED is elastic, who benefits the most from a subsidy?

Answer 33

Most benefit passed on to producers as there is little change in price.

Question 34

If PES is elastic, who benefits the most from a subsidy?

Answer 34

Most benefit passed on to consumers, as there is a fall in price.

Question 35

If PED is unitary, who benefits the most from a subsidy?

Answer 35

Producers and consumers benefit equally.

Question 36

If PES is unitary, who benefits the most from a subsidy?

Answer 36

Producers and consumers benefit equally.

Question 37

If PED is perfectly elastic, who benefits the most from a subsidy?

Answer 37

Whole benefit passed on to producers.

Question 38

If PES is perfectly elastic, who benefits the most from a subsidy?

Answer 38

Whole benefit passed on to consumers due to a fall in price.

Question 39

If PED is perfectly inelastic, who benefits the most from a subsidy?

Answer 39

Whole benefit passed on to consumers through a fall in price.

Question 40

If PES is perfectly inelastic, who benefits the most from a subsidy?

Answer 40

Whole benefit passed on to producers.