Transcript Indirect taxes, Subsidies & Price Controls 6 - IBECON

IB Economics
Indirect Taxes,
Subsidies and Price
Controls
Taxes
Indirect
Direct
A tax on income
A tax on expenditure
Flat (Specific)
Ad- Valorem
(Percentage)
An indirect tax of an absolute
An indirect tax, which is
(constant) amount levied per
unit of a commodity ex: a tax of expressed as a proportion
(percentage) of the price
$5 per unit.
►An
Indirect Taxes
indirect tax is a tax imposed
upon expenditures.
►An indirect tax acts as an extra
cost on the producer; therefore, it
manages to shift its supply curve to
the left.
►An indirect tax is placed on top of
the selling price; hence, raising the
products price and reducing the
quantity demanded.
A Flat (Specific) tax
S2
P
S1
$5
P2
P1
$5
D
With a flat
tax, there is
a parallel
shift of the
supply curve
leftwards by
the amount
of the tax, in
this case $5.
Q
An ad-Valorem (Percentage) tax
S2
P
S1
P2
P1
D
With an AdValorem tax,
the supply
shifts further
to the left at
higher
prices.
Q
How does a tax affect consumers,
producers, the government and the
market?
S2
P
P2
P1
Q2 Q1
The tax causes a
S1
decrease in supply,
which in turn causes
an increase in the
equilibrium price from
P1 to P2. The higher
price causes a
contraction in demand
from Q1 to Q2. This
contraction in market
D size might pose an
unemployment
Q problem.
Who pays for the Tax?
► The
tax causes an increase in the equilibrium
price.
 The consumer bears some of the tax burden.
► The producer—usually—does not pass the entire
tax burden to the consumer. Why??
 The producer realizes that an increase in the
price will result in reduced quantity demanded
(The law of demand).
► The tax could generally be subdivided into 2
parts: The consumer’s burden and the
producer’s burden. Call them C and S
respectively.
The consumer’s burden
S2
P
P2
P1
S1
C
D
The tax is the
vertical distance
between the 2
supply curves.
C represents the
consumer’s
burden and is
equal to the
increase in price
from P1 to P2.
Q
The Producer’s burden
S2
P
S1
P2
P1
S
D
S represents
the producer’s
burden and is
equal to the
remaining part
of the tax.
Q
Tax Revenue
S2
P
S1
P2
P1
Tax Revenue
D
The Tax
revenue is
equal to the
product of the
tax per unit
with the
quantity sold
Q
Q2
Q1
►A
Why give a subsidy?
subsidy is the amount of money paid by the
government to the producers to lower the
producer’s costs of production.
► Governments extend subsidies…
 To lower prices of essential goods, for example
bread, in hope of increasing their consumption.
 To guarantee the supply of products that the
government thinks are necessary for the economy,
such as oil and food.
 To protect industries supplying a lot of employment
that would be lost otherwise causing further
economic and social problems.
 To enable producers compete with overseas trade,
thus protecting domestic industries.
The effect of a subsidy on
supply
S
Price
S - Subsidy
Pe
Subsidy passed to
consumers as
lower prices
PSubsidy
Ps
Subsidy retained
by producer
D
Q1 Q2
Quantity
Subsidy given out to Producers
The subsidy causes
an increase in supply,
which in turn causes a
decrease in the
equilibrium price from
Pe to PSubsidy. The
lower price causes an
extension in demand
from Q1 to Q2.
The effect of subsidy on supply
► The
subsidy will shift the supply curve to the
right by the amount of the subsidy because it
reduces the costs of production for the firm.
► The subsidy will cause the price to drop and
the quantity demanded to increase.
► The price will not fall by the full amount of
the subsidy; however, consumers get to buy
more units at a lower price.
► The amount of the subsidy involves an
opportunity cost to the government. The
money must be taken away from other
governmental projects, or it may raise taxes
in the future.
Equilibrium
P= 10 ; Q= 60
25
Price
20
15
10
5
0
0
20
40
60
80
Quantity
100
120
140
In equilibrium…
► The
quantity
P
demanded is equal
to the quantity
supplied
PE
► No shortage
► No surplus
► No tendency for the
price to change
S
D
QE
Q
Price Controls
►The
free market does not always lead
to the best outcomes for all producers,
consumers or the society in general,
and so governments intervene in the
market to correct the situation.
►Two
forms of government intervention
in markets are:
 Price ceiling or Maximum (low)
 Price floor or Minimum (high)
►A
Price Ceiling
price ceiling is a legal maximum
imposed by the government to help
reduce the price of necessities
and/or merit goods. The price is
not allowed to exceed the price
ceiling.
►The price ceiling is imposed below
the equilibrium price.
Example
►Rent
Controls
 Governments may attempt to impose maximum
prices on rented accommodation to ensure
affordable accommodation for those on low
incomes
►Staples
 Governments may set maximum prices in agricultural and
food markets to ensure low-cost food for the poor.
►Bread
Price ceiling
P
S
PE
Pmax
D
Qs
Qd
Q
Shortage
At Pmax, there
is a shortage.
The quantity
demanded by
buyers, Qd
exceeds the
quantity
supplied, Qs.
Problems
►Long
lines
►Black market, where products are
sold at higher prices.
►Favoritism
Government’s attempts to reduce
the shortage
►
The government can solve these problems either
through:
A. Shifting the demand curve to the left (which defies the
purpose)
OR
B. Shifting the supply curve to the right
•
•
•
►
►
Subsidies
Direct provision
Releasing previously stored stock
A rationing scheme could be used
 e.g. ration coupons
Opportunity Cost
 If the government spends money supporting such
industries, it may have to reduce spending on other
areas, like bridges and railways.
Government’s attempts to
reduce the shortage
P
S2
S1
PE
Pmax
D
Qs
Qd
Q1
Q2
Q
Shortage
If the government
subsidized the
products,
produced it or
released stored
stocks, the supply
will shift to the
right and a new
equilibrium will be
created at Pmax.
Price Floor
►A
price floor is a legal minimum
imposed by the government to help
increase the income of producers
of goods and services deemed
important. The price is not allowed
to fall below the price floor.
►The price floor is imposed above
the equilibrium price.
Examples
► Price
supports for commodities ( agricultural
and industrial raw materials), whose prices
are subject to large fluctuations or to
protect them from foreign competition.
► The
minimum wage set to protect workers
and ensure that they earn enough to lead a
reasonable life.
Price floor
P
S
Pmin
PE
D
Qd
Qs
Q
Surplus
At Pmin, there
is a surplus.
The quantity
supplied by
producers, Qs
exceeds the
quantity
demanded, Qd.
The minimum wage
S
W
Wmin
(by workers)
The minimum
wage results in
excess supply of
labor, i.e.
unemployment
W*
D (by firms)
Qd
Qs
L
Surplus
Government Intervention
►
To eliminate the surplus, the government attempts to:
 Buy the surplus
 In the case where the surplus is bought there is a number of options
available to deal with the stocks
► It
can be stored ; however, some items (fresh ones) cannot be
stored for long periods of time and can therefore be
immediately ruled out. Even the ones that can be stored will
result in high storage costs.
► It can be destroyed, but this is considered to be wasteful.
► It can be sold to other countries; however, selling the stock
abroad could be regarded as dumping and therefore not
welcomed by other countries.
► It can be given as overseas assistance, but this encourages the
overdependence of LDCs on MDCs and discourage them from
pursuing their own growth strategies.
 Limit producers by quotas
 Advertise to create more demand
Problems
►The
minimum wage results in
unemployment
►Price floors imposed on commodities
 Taxpayers will bear the burden of
this policy as the government will
need to buy the surplus
 Higher prices paid by consumers
The End