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Indirect Taxes , Subsidies , and         Price Controls
The effect of an indirect tax on the demand for, and supply of, a product• Taxes and subsidies have and effect upon  deman...
Indirect taxes• Indirect taxes are  imposed on expenditure.• It raises the firm’s costs  and shifts the supply  curve to t...
The main reasons for government imposing taxes can beTo generate Government revenues: excise duties on beers, wines and sp...
Two types of Indirect Taxes• A specific tax: It is a fixed amount of tax  imposed upon a product
Two types of Indirect Taxes• A percentage tax(Ad valorem tax): This is a tax  imposed as a percentage of the selling price...
Distinction between specific and ad             valorem taxesSpecific tax is a flat rate of tax whereas ad valorem tax is ...
Producer revenue
What will happen to the price that the           consumer pay?
What will happen to the amount  received by the producer
Government tax revenue and tax          burden
Share of tax burden for consumers and              producers.• Incidence of an  indirect tax on  consumers and  producers ...
Share of tax burden for consumers and              producers.• Situation 2: PES   PED
Rules in Incidence of Indirect Tax• 1. PED = PES       Burden equally shared  between consumers and producers.• 2.PED > PE...
The effect of a subsidy on the demand     for, and supply of, a product• A subsidy is an amount of  money paid by the gove...
Reasons for Subsidies• To lower the price essential  goods. Encouraged by lower  price, consumption will be  increased.• T...
How is it helping?• When subsidy is granted,  supply curve will shift  vertically downwards by  the amount of the  subsidy...
Specific subsidies and percentage               subsidies• A specific subsidy is a specific  amount of money that is given...
Increase in producer revenue• The market is in equilibrium  at Qe.• When a subsidy of WZ per  unit is granted, supply curv...
Influence of subsidies on consumer              expenditure• Subsidies always makes  the consumer able to  spend more.• In...
Influence of subsidies on consumer              expenditure• In the diagram, as price  decreased from Pe to  P1, the consu...
Cost of subsidy to the governement• The total cost for the  government is the  shaded area on the  diagram[P1DWZ]• This mo...
Cautions/Pre-cautions while granting              subsidies• The opportunity cost  involved.• Whether subsidy will allow  ...
Price Controls• The free market does not always lead to the  best outcomes for all producers and  customers, or for societ...
Maximum(low) price controlsThis is a situation wherethe government sets amaximum price, below theequilibrium price.This ...
• Excess demand leads to black  market.• The shortage of goods needs to  be eliminated.• Two options:• 1. Shift the demand...
Minimum(high) price controls• This is a situation where  govt. sets a minimum  price, above the  equilibrium price.• This ...
Why minimum price?• To raise incomes for  producers of goods and  service that the govt. thinks  are important.(large  flu...
Maintaining minimum price through         govt. intervention• The govt. can  eliminate the  excess supply by  buying up th...
What the government will do with                this?• But the govt. has to either store it or destroy  it; both are expen...
Maintaining minimum price through         govt. intervention• Quota: Producers could  be limited by quotas.               ...
Maintaining minimum price through         govt. intervention• Govt. could attempt to  increase demand for the  product by ...
• But if the governments protect firms by  guaranteeing minimum prices,• Firms will become less cost-conscious and may  le...
Indirect taxes, subsidies and price controls
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Indirect taxes, subsidies and price controls

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Indirect taxes, subsidies and price controls

  1. 1. Indirect Taxes , Subsidies , and Price Controls
  2. 2. The effect of an indirect tax on the demand for, and supply of, a product• Taxes and subsidies have and effect upon demand and supply and is influenced by relative price elasticities of the product.
  3. 3. Indirect taxes• Indirect taxes are imposed on expenditure.• It raises the firm’s costs and shifts the supply curve to the left.• The vertical difference between two supply curve measures the tax amount.
  4. 4. The main reasons for government imposing taxes can beTo generate Government revenues: excise duties on beers, wines and spirits are priceinelastic in demand, so tax price increases by levying specific alcohol and tobacco taxesraise consumer expenditures as a whole on these categories and therefore taxationrevenues;To discourage consumption: Government might use taxes to discourage consumption ofcertain demerit goods such as cigarettes.To alter the pattern of consumption: Government might use direct taxes as a mean toalter the consumption patter of its population. Certain goods can be made more priceattractive through lower taxes while goods which have high marginal social cost can bemade expensive through taxation.
  5. 5. Two types of Indirect Taxes• A specific tax: It is a fixed amount of tax imposed upon a product
  6. 6. Two types of Indirect Taxes• A percentage tax(Ad valorem tax): This is a tax imposed as a percentage of the selling price.• As the price increase, the tax amount also will be bigger.
  7. 7. Distinction between specific and ad valorem taxesSpecific tax is a flat rate of tax whereas ad valorem tax is a percentage tax.Ad valorem literally the term means “according to value.” It is imposed on thebasis of the monetary value of the taxed item.A specific tax is when specific amount is imposed upon a good, for example $10on each mobile phone sold; whereas ad valorem tax is expressed as a percentageof the selling price e.g. 12% of the sales.The amount of specific tax changes in the same proportion as the quantity soldincrease, whereas, in ad valorem the tax collected is more at higher prices thenat lower prices.
  8. 8. Producer revenue
  9. 9. What will happen to the price that the consumer pay?
  10. 10. What will happen to the amount received by the producer
  11. 11. Government tax revenue and tax burden
  12. 12. Share of tax burden for consumers and producers.• Incidence of an indirect tax on consumers and producers is greatly influenced by the PED and PES of the commodity.• Situation 1: PED PES.
  13. 13. Share of tax burden for consumers and producers.• Situation 2: PES PED
  14. 14. Rules in Incidence of Indirect Tax• 1. PED = PES Burden equally shared between consumers and producers.• 2.PED > PES Burden more on producers than on consumers.• 3. PED < PES Burden more on consumers than on producers.
  15. 15. The effect of a subsidy on the demand for, and supply of, a product• A subsidy is an amount of money paid by the government to producers or consumers per unit of output.• A subsidy has an opposite effect of a tax.• Subsidies may be regarded as negative indirect taxes.
  16. 16. Reasons for Subsidies• To lower the price essential goods. Encouraged by lower price, consumption will be increased.• To guarantee the supply of products that the govt thinks are necessary for the economy.• To enable producers to compete with overseas trade and to protect the home industry.
  17. 17. How is it helping?• When subsidy is granted, supply curve will shift vertically downwards by the amount of the subsidy.• It lowers the prices.• This is again depended on the relative elasticities of demand and supply.
  18. 18. Specific subsidies and percentage subsidies• A specific subsidy is a specific amount of money that is given for each unit of the product. (eg:$3 per unit)• A percentage subsidy is fixed on the basis of the price of the product. As the price increases, amount of subsidy also increase.• But this is very rare in practice.
  19. 19. Increase in producer revenue• The market is in equilibrium at Qe.• When a subsidy of WZ per unit is granted, supply curve shifted from S to S-Subsidy .• Producer lowers the price and increase the output till the new equilibrium is reached at P1 price and Q1 quantity demanded and supplied.• Income of producer rises from OPeXQe to ODWQ1
  20. 20. Influence of subsidies on consumer expenditure• Subsidies always makes the consumer able to spend more.• In the diagram, as price decreased from Pe to P1, the consumption expenditure increased by QeQ1 {PED is elastic}
  21. 21. Influence of subsidies on consumer expenditure• In the diagram, as price decreased from Pe to P1, the consumption expenditure increased by QeQ1 {PED is inelastic}
  22. 22. Cost of subsidy to the governement• The total cost for the government is the shaded area on the diagram[P1DWZ]• This money has to be taken away from other areas or it must raise the taxes.
  23. 23. Cautions/Pre-cautions while granting subsidies• The opportunity cost involved.• Whether subsidy will allow firms to be inefficient.• Subsidies are ultimately funded by tax payer. Who is paying the taxes?• Whether it is causing any damages to the foreign producers who are not receiving subsidies?
  24. 24. Price Controls• The free market does not always lead to the best outcomes for all producers and customers, or for society. So the govt. intervention is necessary.• The main two interventions are through:• Maximum prices and• Minimum prices.
  25. 25. Maximum(low) price controlsThis is a situation wherethe government sets amaximum price, below theequilibrium price.This prevents producersfrom raising the price aboveit.This is also known as theceiling price.Normally imposed whenthe good is a necessity and/or a merit good.
  26. 26. • Excess demand leads to black market.• The shortage of goods needs to be eliminated.• Two options:• 1. Shift the demand curve to the left.(Not a good move!)• 2. Shift the supply curve to the right. This can be done through:• (a) Offer subsidies to encourage production.• (b) Govt directly producing goods.• (c ) Release the old stock.
  27. 27. Minimum(high) price controls• This is a situation where govt. sets a minimum price, above the equilibrium price.• This prevents producers from reducing the price below it.• This is also known as floor prices.
  28. 28. Why minimum price?• To raise incomes for producers of goods and service that the govt. thinks are important.(large fluctuations in price or lot of foreign competition)• Setting minimum wages helps the workers earn a reasonable income.
  29. 29. Maintaining minimum price through govt. intervention• The govt. can eliminate the excess supply by buying up the excess products at the minimum price and thus can shift the demand curve to the right
  30. 30. What the government will do with this?• But the govt. has to either store it or destroy it; both are expensive• Can sell outside?....will lead to angry reactions from foreign govts. for dumping.
  31. 31. Maintaining minimum price through govt. intervention• Quota: Producers could be limited by quotas. Quota• It restricts the supply at Q1(as per the diagram)• It would keep price at Min P
  32. 32. Maintaining minimum price through govt. intervention• Govt. could attempt to increase demand for the product by advertising or by restricting supplies from abroad through protectionist policies.
  33. 33. • But if the governments protect firms by guaranteeing minimum prices,• Firms will become less cost-conscious and may lead to inefficiency.

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