2.7a Role of government in microeconomics [TAX + SUBSIDY] Flashcards
Why do governments intervene?
To earn government revenue
To support low income households
To support firms
To influence the level of production/consumption
To correct market failure
To promote equity
How does the government earn revenue?
- Direct + Indirect tax
- Sales of good and services (eg. public transport)
- Privatisation proceeds
- Sovereign wealth funds (state owned investments)
What are Indirect taxes?
Is levied on the expenditure on goods and services. They are imposed on producers who then pass on part of (or all of) the tax to consumers.
What are the two types of indirect taxes?
- It can be a specific tax, (per unit tax.)
- Imposes a fix amount of tax on each unit sold (eg. air passenger tax, or excise duty on cigarettes). - Ad valorem tax:
- Imposes a percentage tax on the value of goods and services sold (eg. VAT)
What type of indirect tax is shown here?
specific tax, (per unit tax.)
[Explanation of DIG:]
The air passenger tax increases the costs of production to airline ticket firms and this will cause a left shift in supply from S to S1 (which is S + taxes). This results in a higher price from P to Pc and a decrease in quantity from Q to Q1.
Pc is the price charged to consumers by producers, Pp is the price received by the producers as they have to pay the unit per tax to the government (so the producers don’t get the 10€, the government does).
What type of indirect tax is shown here?
Ad Valorem tax:
The Supply curves aren’t parallel. As the price increases, the tax increases (even though the % stays the same).
What is the impact of indirect taxes on government?
–> Better off as it will increase the government revenue
What is the impact of indirect taxes on consumers?
Consumers are worse off as they now have to pay more for goods and services. They will especially pay a much higher price if the producer passes on all of the tax to them. (ie. if the price for the product is perfectly inelastic).
- -> Consumer surplus decreases
- -> Indirect taxes are regressive. Therefore the indirect taxes affect low-income earners more than high-income earners.
What is the impact of indirect taxes on producers?
- -> Firms are also worse off as their costs of production increase and they lose revenue
- -> Producer surplus decreases
On this indirect tax diagram, what are the:
- tax rev to gov
- burden of tax on consumer
- burden of tax on producer
Tax rev to gov = Pc, A, C, Pp
Burden of tax on consumer = Pc, A, B, P
Burden of tax on producer = P, C, B, Pp
What does the effectiveness of the indirect tax depend on?
! Depends on the PED and PES !
If the demand for the product (the cigarettes) is price inelastic, firms can pass on most of the tax onto consumers. Therefore the consumers will have a greater burden of the tax than producers as they are unresponsive to changes in price.
What is a subsidy?
A subsidy is a payment (a form of financial assistance) from government to firms to encourage production, by reducing a firms cost of production.
On this subsidy diagram: What is the original and new price and output level?
Original price and output level = P, Q
New price and output level = Pp, Q1
On this subsidy diagram: What is the original and new revenue received by the produce?
Revenue received by producer before subsidy = P , C, Q, O
Revenue received by producer after subsidy = Pp, A, Q1, O
On this subsidy diagram: What is the government spending on this subsidy?
- per unit = A, B
- whole subsidy = Pp, A, B, Pc
On this subsidy diagram: What is the change in consumer surplus?
- before subsidy = P, C, F
- after subsidy = Pc, B, F
Gain/ loss of consumer surplus?
–> Gain, gained area (P, C, B, Pc)
On this subsidy diagram: What is the change in producer surplus?
- before subsidy = P, C, G
- after subsidy = Pp, A, G
Gain/ loss of producer surplus?
–> Gain, gained area (P, C, A, Pp)
