Indirect Taxes

Unit 4 - Lesson 1

Learning outcomes:
Explain why governments impose indirect taxes.
Distinguish between specific and ad valorem
taxes.
Draw diagrams to show specific and ad valorem
taxes.
Discuss the consequences of imposing indirect
taxes on stakeholders in a market - consumer,
producer and the government.

Government Intervention
What you have learned so far relates to free
markets.
In the world today most markets are not free
markets, but are considered mixed markets.
Mixed Market:
Free Market + Government Intervention

How Governments Intervene...

Government Intervention into Free Markets:
1. Taxes
2. Subsidies
3. Price Controls

Indirect Tax
Taxes placed on goods and services.
Called Indirect Taxes because the Consumer
indirectly pays them to the Government.
Consumer - Seller - Government

Indirect Taxes
Two types (excise taxes):
Specific Tax: the amount of tax is an absolute
value per unit.
Example $2 per unit.
Ad Valorem Tax: Percentage of the sale.
Example 8% of sale.

Specific Tax
Specific Tax - Flat Tax
Specific amount charged
per unit of product sold.
On the graph to the right:
25p per unit sold

Ad Valorem Tax
Ad Valorem - (VAT)
Percentage tax on a
good or service.
The higher the price, the
overall amount of tax
collected increases.

Effect of Taxes:
Consequences to the stakeholder:
1. Consumers
2. Producers
3. Government

Consequences:
1.

Increase prices: Determinant of Supply

2.

Reduce the output: Smaller quantities offered for sale.

3.

Market size gets smaller because of reduced output.

4.

Consumers suffer: pay higher price & receive less product.

5.

Producer suffer: Increase costs, produce less & profits become smaller.

6.

Government: Increase the revenue for the government.