Transcript How Taxes reduce demand for a demerit good

Taxation and Subsidies
Purpose and Effect
taxation
A tax is a government policy that allows the government to obtain a sum of money from
consumers or firms for various purposes.
Its purpose
1. For government to obtain funds to run the country
2. For government to reduce or curb the consumption or use of an undesirable good (eg.
demerit goods like cigarette, alcohol etc)
3. To help government to reduce the income difference by redistributing monies from higher
income earners to lower income earners.
[demerit good - a good whereby if the government left it to the free market, will be over produced to the extent that it gives
of negative externalities and causing markets failure)
Taxation
1. For government to obtain funds to run the country
- By using direct tax - eg income tax, tax on property etc.
(direct tax meaning the one has to pay the government directly)
- By using indirect tax - eg Goods and Service Tax (GST), Electronic Road Pricing (ERP)
(indirect tax meaning someone will pay the tax to the government on your behalf eg. the
711 store, petrol station etc.
Taxation
Demerit goods like cigarettes and alcohol affect the environment negatively as well as give rise to social ills. Because
of this, the government needs to reduce their consumption (ie. reduce their quantity demanded.
P
How Taxes reduce demand for a demerit good
S1
S0
E1
P1
When an indirect is applied (eg. GST), this will increase
the cost of production of a firm. (or a producers). As such,
owing to the tax, the supply curve will shift leftward from
S0 to S1 as now less is being produced at every price
level owing to the tax.
E0
P0
D
Q1
Q0
Assuming that the initial market equilibrium (E0) the
market clearing price and output is P0 and Q0
respectively.
Owing to the tax, the prices will increase from P0 to P1
and output will be cut back from Q0 to Q1.
With a tax, the government objective of reduction of the
Q demerit good is achieved as its consumption is now
decreased from Q0 to Q1.
Taxation
Amount of tax as represented in the diagram.
P
S1
S0
E1
P1
Amount of Taxation on each unit of the good
eg. Cigarettes= P1 – P2
Total Amount of Taxation on the good is = Area
P1P2ZE1
E0
P0
P2
D
Z
Q1
Q0
Q
Taxation
3. For the re-distribution of wealth.
- The difference in incomes between the highest earners and lowest earners
in a country is called the income gap.
- If the income gap is too wide, this means that the rich are getting richer and
poor are getting poorer. The governments needs to ensure that the people’s
incomes are as equitable as possible so that they poor will not be exploited.
- Taxes have the ability to take some from the richer to help supplement the
poorer people’s income.
subsidies
Subsidies are given to help promote the consumption or production of a merit good that
gives off positive externalities to society.
A merit good is a good that when left to the free market will be under consumed or
underproduced.
Subsidies
Demerit goods like cigarettes and alcohol affect the environment negatively as well as give rise to social ills. Because
of this, the government needs to reduce their consumption (ie. reduce their quantity demanded.
P
How subsidies increase demand for a merit good
S0
S1
P0
Assuming that the initial market equilibrium (E0) the
market clearing price and output is P0 and Q0
respectively.
When a subsidy is given, this will reduce the cost of
production of a firm. (or a producers). As such, owing to
the subsidy, the supply curve will shift rightward from S0
to S1 as now more is being produced at every price level
owing to the subsidy.
P1
D
Q0
Q1
Owing to the subsidy, the prices will decrease from P0 to
P1 and output will be increase from Q0 to Q1.
With a subsidy, the government’s objective of increasing
Q of comsumption of a merit good is achieved as its
consumption is now increased from Q0 to Q1.
Subsidies
Amount of subsidy as represented in the diagram.
P
S1
Z
P2
S0
E0
Amount of Subsidy for each unit of the
good. Eg. H1N1 Vacination = P2 - P0.
P1
Total Amount of subsidy is = Area
P2P0E1Z
E1
P0
D
Q0
Q1
Q