indirect tax and subsidies

• What is an indirect tax?

  A tax on expenditure charged to consumers
• Who ultimately pays an indirect tax?

  The customer is charged the tax
• What are the two types of indirect tax?

  • Ad valorem tax
  • Specific tax
• How does an ad valorem tax work?

  It increases in proportion to the value of goods
• What is an example of an ad valorem tax?

  Value Added Tax (VAT)
• How does a specific tax function?

  It adds a fixed amount to the price
• What is an example of a specific tax?

  Excise duties on alcohol
• What are the impacts of a specific tax on supply and price?

  • Supply shifts from S1 to S2
  • Price rises from P1 to P2
  • Output falls from Q1 to Q2
• What does the orange area in the tax impact diagram represent?

  The consumer's tax burden
• What does the grey area in the tax impact diagram represent?

  The producer's tax burden
• How is government tax revenue calculated in the tax impact diagram?

  It equals $AB \times Q2$
• How does an ad valorem tax affect the supply curve?

  • Supply curve shifts and tilts
  • Gap between S1 and S2 grows
  • Tax is a percentage of value
• What is the incidence of tax?

  The tax burden on the taxpayer
• What happens if the demand curve is perfectly elastic?

  The supplier pays all the tax
• What occurs if the demand curve is perfectly inelastic?

  All tax is passed to the consumer
• How does elasticity of demand affect tax incidence?

  More elastic demand lowers consumer tax burden
• What is the relationship between demand elasticity and government tax revenue?

  More inelastic demand increases tax revenue
• What is a subsidy?

  • A grant from the government
  • Encourages production/consumption
  • Opposite of a tax
• What types of goods might receive subsidies?

  Necessities like bread and local manufacturers
• What is the purpose of a subsidy?

  To encourage production or consumption