1.2.9 Indirect Taxes & Subsidies

• Indirect taxes are imposed by the government and they increase production costs for producers. Subsequently, producers supply less, and this increases market price and demand contracts.
• Types of Indirect Taxes

  1. Ad Valorem
  2. Specific Taxes
• Ad valorem taxes are charged as a percentage of the price of a good.
• Specific tax is charged as a fixed amount per unit of output.
• Indirect taxes are shown on a diagram by the vertical distance between the two supply curves.

  
• Since ad valorem tax is the percentage of the cost of the good, it increases the price of the good, causing the supply curve to pivot.

  
• A subsidy is a payment from the governemnt to a producer to lower their costs of production and encourage them to produce more.
• Subsidies shift the supply curve to the right, which lowers the market price and increases the quantity supplied.

  
• On a subsidy graph, the vertical distance between the supply curves shows the value of the subsidy per unit.
• Government Spending on Subsidy = Value of the Subsidy per Unit x Output
• Benefits of Subsidies

  1. Increase output and lower consumer prices.
  2. Increase employment rate through apprenticeship schemes.
  3. Reduce societal inequality
  4. Help to control inflation
  5. Boost demand during economic decline
• Disadvantages of Subsidies

  1. Could cause government failure if inefficient or distorts market price.
  2. Government revenue could be spent elsewhere.
  3. The tax payer may not receive any direct benefit.
• Consumer subsidies affect demand and do not shift the supply curve.
• Producer subsidies lower the cost of production and shift the supply curve.