effects of taxes + subsidies (1)

Question 1

microeconomic effects of imposing an indirect tax

Answer 1

• reduced overconsumption + internalised -ve externalities in consumption -> demerit goods -> overconsumed due to imperfect info (consumers underestimate long-term costs + benefits) -> tax -> incr production costs -> fall in supply -> incr prices -> contraction in quantity demanded -> fall in consumer surplus -> private cost is closer to social cost -> reduces overconsumption + welfare gain
• reduced profit margins for firms -> increased COP -> less revenue (positive XED -> Qd for substitutes like bottled water rise) + profits for producers -> less available funds for capital investment -> reduced dynamic efficiency -> limited quality of services -> smaller firms may not be able to absorb cost -> SR = firms may try to stay afloat by cost-cutting measures i.e. reducing staff -> LR - if AR<AC -> small firms forced to exit market -> loss of employment + market diversity

Question 2

evaluate the effects of imposing an indirect tax

Answer 2

EXTERNALITIES MAY NOT BE INTERNALISED BECAUSE
- effectiveness depends on PED -> may be price inelastic due to addictiveness + strong brand loyalty -> less sensitive to price changes -> externality not fully internalised = overconsumption may persist -> this would disproportionately affect low-income households -> pay a higher % of their income -> may encourage them to switch to cheaper, but more harmful alternatives -> unintended consequences -> increased welfare loss -> gov. failure
PROFITS MAY NOT FALL BECAUSE
- tax may incentivise firms to innovate + reformulate products -> e.g. ‘zero-sugar’ products to avoid the levy whilst maintaining sales -> loss of profits is small -> firms who adapt quick enough can retain market share -> protect their margins + can diversify their product range overtime in healthier markets -> can lead to healthier consumer choices

Question 3

judgement: evaluate the effects of taxes

Answer 3

tax may reduce profits, disproportionately affecting smaller firms, whilst also playing a role in internalising negative externalities.
however, the extent of success depends heavily on PED and the ability of a firm to produce healthier alternatives.

Question 4

microeconomic effects of imposing subsidies on a particular industry (electric vehicles) [KAA1 - consumers + society]

Answer 4

LOWER PRICES FOR CONSUMERS
- define subsidy -> financial payment by the government to firms to reduce production costs -> reduces production costs for EV manufacturers -> shifts supply curve outwards (S1->S1+subsidy) -> market equilibrium price falls (P1->P2) -> lower prices + greater choice -> increased consumer surplus -> improved consumer welfare -> fall in price = brings market closer to socially optimum point as EV market has positive consumption externality (merit good = underconsumed; reduced air pollution) -> internalised externality -> corrects market failure -> improved allocative efficiency

diagram -> subsidy diagram AND/OR +ve consumption externality

Question 5

evaluate microeconomic effects of imposing subsidies on a particular industry (KAA1 - on consumers + externalities)

Answer 5

SUBSIDY MAY NOT BE SIGNIFICANT BECAUSE
- effectiveness depends on PED -> demand for EV may be price inelastic -> due to: brand loyalty, low substitution w/ electric cars -> consumers less sensitive to price changes -> much of the subsidy is absorbed by producers + less incentive to reduce prices -> higher profit margins -> weakens the expected welfare gain
- effectiveness depends on access to information -> consumers may be unaware of cost savings -> increase in demand may be muted -> less promotion of +ve externalities

Question 6

judgement: microeconomic effects of subsidies

Answer 6

overall, while subsidies can lower prices + boost production for firms, thus improving allocative efficiency + potentially creating more jobs -> depends heavily on PED + the magnitude of the subsidy

Question 7

microeconomic effects of imposing subsidies on a particular industry (electric vehicles) [KAA1 - producers + workers]

Answer 7

INCREASED PROFITS FOR PRODUCERS + INCREASED EMPLOYMENT
- reduced production costs -> lower AC -> increased profits + improved productive efficiency -> encourages higher output -> more funds available for capital investment (R&D) -> improved dynamic efficiency + ability to exploit technical economies of scale -> reduced LRAC -> improved quality of goods + services -> improved non-price competitivess
- more output -> increased derived demand for labour in EV market + supporting industries (E.g. battery manufacturing

diagram: cost/revenue curve showing AC/MC falling

Question 8

evaluate microeconomic effects of imposing subsidies on a particular industry (electric vehicles) [KAA2 - producers + workers]

Answer 8

EFFICIENCY MAY NOT IMPROVE
- subsidies can create producer dependency -> if EV sector over-relies on gov. support -> firms lack incentive to control costs or innovate -> X-inefficiency -> higher costs than necessary -> generate less profits + less funds for investment
- subsidies may distort the market -> smaller competitors who cannot compete with subsidised firms may suffer
LIMITED EMPLOYMENT GAINS BECAUSE
- the sector is highly capital intensive -> firms more likely to invest in automation instead of hiring more workers