Unit 3.2: Government interventions

• Indirect taxes


  Taxes taken indirectly from incomes when they are spent on goods and services

  
• Specific tax


  An indirect tax that is fixed per unit purchased

  
• Ad valorem tax


  A tax that is charged as a given percentage of the price

  
• Tax burden


  The total tax revenue as a proportion of the national income of a country
• How taxes are used

  • To raise revenue
  • To manage the macroeconomy
  • To reduce income inequality after tax
  • To discourage spending on imports
  • To discourage the consumption and production of harmful products
  • To protect the environment

  
• Increase in income tax rates raises $3 billion
• Tax cuts to boost employment and growth

  
• America's soft drinks industry battles proposals to tax sugary sodas
• India introduces carbon tax on coal producers
• Types of taxes


  • Direct taxes
  • Indirect taxes

  
• Direct taxes


  Taxes taken directly from individuals or firms and their incomes or wealth

  
• Why do governments want to increase the prices and restrict the supply of some products?
• Why do governments want to increase the supply and reduce the prices of some products?
• Incidence of tax


  Refers to how the burden of a tax is distributed between firms and consumers. The tax incidence depends upon the relative elasticity of demand and supply.

  
• Consumer burden of a tax increase

  The amount by which the market price rises
• Producer burden


  The decline in revenue firms face after paying the tax
• Subsidies


  A sum of money granted by the state or a public body to help an industry or business keep the price of a commodity or service low

  
• Subsidies have the opposite effect of indirect tax
• Incidence of a subsidy


  How the burden of a subsidy is distributed between firms and consumers

  
• Problems with a subsidy
• Objective: To reduce harmful exhaust emissions by the reducing the consumption of petrol

  1. Before tax of 40 cents per litre: 500 million litres of petrol are traded each month at the market price of 80 cents per litre

  2. After tax of 40 cents per litre: 400 million litres of petrol are traded each month at a new market price of $1 per litre
• Why doesn't the market price rise from 80 cents to $1.20 per litre?
• Objective: To encourage the production and consumption of biofuel

  1. Before a subsidy of $20 per barrel: 40 million barrels of biofuel are supplied and traded each month at the market price of $60 per barrel

  2. After a subsidy of $20 per barrel: 50 million barrels of biofuel are supplied and traded each month at a new market price of $50 per barrel
• Why doesn't the market price fall from $60 to $40 per barrel?
• Direct provision of goods and services

  Provision of public and merit goods that are under provided by the private sector, financed through tax
• Market failure is the economic situation defined by an inefficient distribution of goods and services in the free market
• In neoclassical economics, market failure is a situation in which the allocation of goods and services by a free market is not Pareto efficient, often leading to a net loss of economic value
• Pareto efficient


  No change can be made without making someone else worse off
• Price maximum


  A price control set by the government below the equilibrium price of the market
• Price ceiling


  The price of the market cannot go above this price
• Problems with a price maximum
• Market response to a price maximum
• Consumer consequences of a price maximum
• Market impact of a price maximum - deadweight loss
• Price minimum


  A price control set by the government above the equilibrium price of the market
• Price floor


  The price of the market cannot fall below this price
• Impact of a price minimum on the market
• Consequences of a price minimum
• Price minimum and minimum wage
• Problems of price controls