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uk

Correcting Market Failure

Subsidies and Taxation

Copyright 2006 Biz/ed

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Subsidies and Taxation

(Subsidies):
(Aim to change relative
prices)
(Given to the producer)
(Used to
help re-distribute income)
(Used
to help firms compete)
,
, ,
, , , , ,
(Numerous examples state benefits, free school meals,
working tax credits, agriculture, transport, regional development,
housing, employment, education)
Copyright 2006 Biz/ed


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Subsidies and Taxation

(Effects of Subsidies):
(Shifts supply curve to right)
(Reduces price to consumer)

(Increases output market failure is perceived as a lack of output)

(Long term effects on market distorts price signals)

(Who benefits depends who gets the
subsidy and how it is used)!
- :
(Welfare effects: cost of
the subsidy to the taxpayer minus the value of the benefits received)

(Impact on relative consumer and
producer surplus)
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SUBSIDIES EFFECTS

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SUBSIDIES AND ELASTICITY
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Copyright 2006 Biz/ed

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Subsidies and Taxation

Price
14
10

S
S + (Subsidy)

Total
cost of the subsidy

(Amount of subsidy per unit) (4)

The
The
subsidy

ofwill
encourage
subsidy

Firstamount
we look
atthe
the
marketis
the

suppliers
vertical

offer
more
between

for sale
before
thetodistance
subsidy
the

at every
two supply

price curves

?

D
500

700

(The effect of the subsidy is to

reduce prices and increase the
amount available but at what
cost?)

Quantity Bought and Sold
Copyright 2006 Biz/ed

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Subsidies and Taxation

(Taxation):

(Specific or
flat rate amount per unit)

(Ad Valorem percentage of the price)

(Levied on the producer indirect tax)
: , , , ,
(, )
(Examples: VAT, excise duties, tariffs, levies, duties (e.g. stamp
duty))
-
? (National Insurance Contributions (NICs) a tax on
employment?)
- - ? (Incidence who pays?)
/
(Producer/consumer price elasticity of demand)
Copyright 2006 Biz/ed


Subsidies and Taxation

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(Effects of a tax):
(Increases price)
/ ,
: (Reduces consumption/output, The
purpose of indirect taxes is to:)
(Generate tax revenue for a
government)
(Discourage consumption
of harmful products)
(Encourage consumption of
good products)
- : (Welfare effects:)

(Burden of tax on producer
and consumer changes in producer and consumer surplus)
(Tax yield
minus the cost of the tax)
Copyright 2006 Biz/ed


Subsidies and Taxation

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(Effects of Taxation):
(Distortion of the market)
(Influence on behaviour)

, ,
, (Extent of the effect
dependent on the degree of elasticity number of substitutes,
addictiveness of the product, proportion of income devoted,
time scale)
,
, .. (Creation of underground markets
smuggling, booze cruises, etc.)
?
(Increases business costs competitiveness?)

(Raises revenue to help pay for government services)
Copyright 2006 Biz/ed

-
Incidence of a tax on petrol
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Price p per litre

76.8

74

S + (tax)
S
= 3 .
Amount of tax = 3p per litre

Tax
Revenue
Tax burden of
consumer

Tax burden
of producer

The
Some
ThePetrol
amount
tax
of the
effectively

of
tax
the

isinelastic
passed
tax
increases
is the
on to the
has
an

vertical
consumer
thedemand
cost

distance
ofinproduction,
the

form
between
.
of shifting
higher

the two
prices
curve

supply

supply
this iscurves
to
thethe
burden

left
of tax

!

D
50
49.5

The producer has to carry the rest of

the burden. With an inelastic demand
this may not be very much!

Quantity Bought and Sold
( 000s (000s litres per day))
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Incidence of an ad valorem tax on a product with a
greater degree of price elasticity

(Price)

S + (Tax)

Burden on Consumer

Total Tax Paid

Burden on
Producer

500

(6)
Amount of the tax (6)
D
900 -
Quantity Bought and Sold
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