Indirect tax- Full Market Impact Flashcards
(19 cards)
What is an indirect tax?
An expenditure tax that increases production costs and can be passed onto consumers through higher prices (e.g. VAT, fuel duty).
What are the main reasons for imposing indirect taxes?
To raise government revenue.
To correct market failures (e.g. reduce negative externalities from cigarettes, alcohol).
What is the difference between indirect and direct tax?
Indirect taxes are levied on goods/services and can be passed to consumers. Direct taxes are levied on income or profits and cannot be passed on (e.g. income tax, NI).
What is a specific tax?
A fixed amount per unit sold (e.g. £2.23 per bottle of wine), shown as a parallel shift in the supply curve.
What is an ad valorem tax?
A percentage of the price (e.g. 20% VAT), causing a pivot in the supply curve; the tax value increases as the price increases.
What happens to the supply curve when an indirect tax is imposed?
The supply curve shifts upwards (or left) because the tax increases costs of production.
How do we represent the tax on a graph?
As the vertical distance between the original supply curve (S) and the new taxed supply curve (S + tax).
What is the new market outcome after an indirect tax is introduced?
Price increases from P1 to P2.
Quantity falls from Q1 to Q2.
The new equilibrium is at the intersection of demand and S + tax.
How do we calculate government tax revenue from the graph?
Multiply the tax per unit (vertical distance between curves) by the new quantity sold (Q2).
This gives the area of the rectangle between the two supply curves up to Q2.
What is consumer burden and producer burden?
Consumer burden: The part of the tax passed on to consumers as a higher price (P2 – P1).
Producer burden: The rest of the tax absorbed by producers as lower revenue per unit.
How do you calculate the consumer burden from an indirect tax?
It’s the price increase (P2 - P1) multiplied by the new quantity sold (Q2); this represents the portion of tax passed onto consumers.
How do you calculate the producer burden from an indirect tax?
It’s the remainder of the tax revenue after subtracting the consumer burden — the part absorbed by producers through lower revenue per unit.
How does an indirect tax affect producer revenue?
Producer revenue falls because they receive a lower effective price and sell fewer units (revenue = price × quantity).
What is deadweight welfare loss (DWL) in this context?
DWL is the lost consumer and producer surplus due to a reduction in market quantity from Q1 to Q2. It represents lost economic efficiency.
Why might consumers dislike indirect taxes?
They raise prices, reduce consumer surplus, limit choice, and are regressive (they take a larger % of income from low earners).
Why might producers and workers dislike indirect taxes?
They cause lower revenue, reduced producer surplus, and possibly job losses due to falling demand and production.
Why might governments like using indirect taxes?
They help raise revenue and correct market failures (e.g., reducing harmful consumption of cigarettes, alcohol, fuel).
What are two key downsides of indirect taxes for governments to consider?
They can be regressive (hurt low-income groups more).
They may lead to black markets or tax avoidance.
