Transcript ###Correcting Market Failure

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Correcting Market Failure
Subsidies and Taxation
Copyright 2006 – Biz/ed
http://www.bized.co.uk
Subsidies and Taxation
• Subsidies:
–
–
–
–
–
Aim to change relative prices
Given to the producer
Used to help re-distribute income
Used to help firms compete
Numerous examples – state benefits, free
school meals, working tax credits,
agriculture, transport, regional
development, housing, employment,
education
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Subsidies and Taxation
• Effects of Subsidies:
– Shifts supply curve to right
– Reduces price to consumer
– Increases output – market failure is perceived as a
lack of output
– Long term effects on market – distorts price signals
– Who benefits – depends who gets the subsidy and
how it is used!
– Welfare effects: cost of the subsidy to the taxpayer
minus the value of the benefits received
– Impact on relative consumer and producer surplus
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Price
Subsidies and Taxation
S
£14
£10
S + Subsidy
Total
cost of the subsidy
Amount of subsidy per unit (£4)
The
The
amount
subsidy
of of
the
will
subsidy
encourage
subsidy
is is
to
Firsteffect
we look
atthe
the
market
the
reduce
suppliers
vertical
prices
offer
and more
increase
between
for sale
the
before
thetodistance
subsidy
the
amount
at every
two supply
available
price curves
– but at what
cost?
£7
D
500
700
Quantity Bought and Sold
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Subsidies and Taxation
• Taxation:
–
–
–
–
Specific or flat rate – amount per unit
Ad Valorem – percentage of the price
Levied on the producer – indirect tax
Examples: VAT, excise duties, tariffs, levies,
duties (e.g. stamp duty) National Insurance
Contributions (NICs) – a tax on
employment?
• Incidence – who pays?
– Producer/consumer – price elasticity of
demand
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Subsidies and Taxation
• Effects of a tax:
• Increases price
• Reduces consumption/output
• Welfare effects:
– Burden of tax on producer and
consumer – changes in producer and
consumer surplus
– Tax yield minus the cost of the tax
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Subsidies and Taxation
• Effects of Taxation:
– Distortion of the market
– Influence on behaviour
– Extent of the effect dependent on the degree of
elasticity – number of substitutes, addictiveness of
the product, proportion of income devoted, time
scale
– Creation of underground markets – smuggling,
booze cruises, etc.
– Increases business costs – competitiveness?
– Raises revenue to help pay for government services
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Incidence of a tax on petrol
Price p per litre
S + tax
S
Amount of tax = 3p per litre
76.8
Tax burden of
Tax
Revenue
consumer
74
The
The
Some
The
producer
amount
tax
of the
effectively
of
tax
has
the
isto
passed
tax
increases
carry
is the
the
on rest
to the
of
Petrol
has
an
inelastic
the
vertical
consumer
the
burden.
costdistance
ofin
With
production,
the an
form
between
inelastic
of shifting
higher
thedemand
two
prices
demand
curve
this
supply
–
supply
this
may
iscurves
not
to
thethe
be
burden
left
very of
much!
tax
Tax burden
of producer
D
50
49.5
Quantity Bought and Sold
(000s litres per day)
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Incidence of an ad valorem tax on a product with a
greater degree of price elasticity
Price
S + Tax
£9
£7
S
Burden on
Consumer
Total Tax Paid
Burden on
Producer
Amount of the tax (£6)
D
£3
500
900
Quantity Bought and Sold
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