1.4.1 government intervention in markets
indirect tax
tax acts like an increase in production costs
ad valorem
percentage of the price of a good
- e,g VAT
- pivotal inward shift of supply
specific
set amount per unit of the product sold
- e,g fuel duty / alcohol and tobacco duty / sugar tax / gambling duties / air passenger
duty
- parallel inward shift of supply
■ all the shifts LABELLED! & tax areas identified (incidence of tax & unit
tax)
○ increased price of good & output falls
○ internalises externalities
○ reduces consumer/producer surplus & effects tax burden on
consumer/producer
○ increased production costs = reduced profits for firms
○ increased tax revenue for government
○ good for environment if it’s a sin tax as demerit goods and have negative
externalities
EVAL
- use tax funds to reduce external costs = internalises effect of demerit goods and
external costs = eliminate welfare loss = social optimum welfare equilibrium position
- effect of PED: more inelastic = greater tax revenue & increased burden on consumer
& less burden in producers
- magnitude of tax
- increased demand for substitutes
- difficulty of imposing tax if hidden market
- time lag - long term effects for govt, funding for other sectors
, subsidies
government grant to firms to increase production and consumption by lowering price of good
- reduce costs of production
- encourage firms to raise supply
- producer subsidy = increased production = lower costs of production = lower
price of good = shifts supply right
- consumer subsidy (e,g childcare vouchers) = increased consumption = shifts
demand right
- Inelastic good subsidised benefits consumer(fuel)
- Elastic goods subsidised benefit producer
indirect tax
tax acts like an increase in production costs
ad valorem
percentage of the price of a good
- e,g VAT
- pivotal inward shift of supply
specific
set amount per unit of the product sold
- e,g fuel duty / alcohol and tobacco duty / sugar tax / gambling duties / air passenger
duty
- parallel inward shift of supply
■ all the shifts LABELLED! & tax areas identified (incidence of tax & unit
tax)
○ increased price of good & output falls
○ internalises externalities
○ reduces consumer/producer surplus & effects tax burden on
consumer/producer
○ increased production costs = reduced profits for firms
○ increased tax revenue for government
○ good for environment if it’s a sin tax as demerit goods and have negative
externalities
EVAL
- use tax funds to reduce external costs = internalises effect of demerit goods and
external costs = eliminate welfare loss = social optimum welfare equilibrium position
- effect of PED: more inelastic = greater tax revenue & increased burden on consumer
& less burden in producers
- magnitude of tax
- increased demand for substitutes
- difficulty of imposing tax if hidden market
- time lag - long term effects for govt, funding for other sectors
, subsidies
government grant to firms to increase production and consumption by lowering price of good
- reduce costs of production
- encourage firms to raise supply
- producer subsidy = increased production = lower costs of production = lower
price of good = shifts supply right
- consumer subsidy (e,g childcare vouchers) = increased consumption = shifts
demand right
- Inelastic good subsidised benefits consumer(fuel)
- Elastic goods subsidised benefit producer
