Evaluate the effect of an indirect tax to reduce consumption of demerit good (Reduce -ve consumption externality in Sugary Drinks,Alcohol,Vapes)

Question 1

KAA1

Answer 1

Market failure is when there is a misallocation of resources. Sugar is a demerit good as it has
negative externalities in consumption that are costs to third parties.

Sugary Drinks=feeling ill
Vapes=Poor respiratory health
Alcohol=Drunk Driving
this can prove to be a burden on family
members, neighbours, or taxpayers, healthcare services. The NHS has states around £16 billion a year is spent on the ‘direct medical costs’ of diabetes and obesity related conditions.

Analyse Diagram:
The free market would have an equilibrium at the point where MPC = MPB as When transacting,
the buyer and the seller did not consider the negative externality of sugary drinks. The socially
optimal quantity is where MSC = MSB. This means we were over consuming. so, the tax would
shift MPC to the left and bring the market closer to Q*.
A tax is a cost of production , reduction in producer surplus that causes supply to shift to the
left. This causes price to go up from p1 to p2 , this will reduce the Consumer surplus.
and the quantity demanded for sugary drinks to fall from q1 to q2.

The cross elasticity of demand should mean consumers switch to healthier drinks switch to
healthier drinks another benefit of a proposed sugar tax is companies will be encouraged to reformulate drinks
due to the increased cost. Firms like Fanta have done it in past.
Reduction in over production and consumption will reduce market failure

Question 2

Eval 1 - Govt failure

Answer 2

Govt Failure
Unintended Consequences: Inelastic Good
One of the problems with indirect taxes is potential government failure in the form of unintended consequences. If the good is inelastic in demand, then quantity demanded will not fall by enough. This is likely to happen because sugary drinks and unhealthy food are addictive and take up a small proportion of income as they are often quite cheap. Therefore, a tax of a sensible percentage is unlikely to deter consumption.

Black Markets:
Due to a reduction in price competitiveness, consumers may switch to black markets to get these goods cheaper. This can be harder and more expensive for the govt to regulate, which also may not decrease the -ve consumption externality

Impact on consumers:
Another negative of taxing an inelastic good is that the consumer burden is much more than the producer burden. The burden of tax on producer… and
consumer………. (shown on diagram)
This is going to affect low income consumers more as indirect taxes are regressive in nature. so therefore it would increase inequality. Although sugary drinks are bad for everyone, it is unfair if the tax affects poorer people more

Question 3

KAA2 - What govt can do with increase revenue

Answer 3

The Govt tax revenue will increase by…. (shown on diagram)
This revenue can be used to further solve the market failure by providing subsidy to improve the quality and affordability of healthy substitute goods such as fresh fruit
juice. A subsidy is a payment that can encourage supply to shift to the right as it lowers costs of production and may allow greater spending to improve or advertise
the products. (subsidy diagram)
Also, could be spent on information campaigns

Question 4

Eval - 2

Answer 4

Companies that offer healthier alternatives may absorb the subsidy meaning that they’re prices stay high
This means they are less price competitive with the unhealthier alternative, as they’re not addictive, PED is possibly relatively elastic, QD won’t increase as much, -ve consumption externality stays high
In addition, there is an opportunity cost with a subsidy