Taxation and Subsidies

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Taxation and Subsidies Purpose and Effect
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taxation
A tax is a government policy that allows the
government to obtain a sum of money from
consumers or firms for various purposes.
Its purpose 1. For government to obtain funds
to run the country 2. For government to reduce
or curb the consumption or use of an undesirable
good (eg. demerit goods like cigarette, alcohol
etc) 3. To help government to reduce the income
difference by redistributing monies from higher
income earners to lower income earners. demerit
good - a good whereby if the government left it
to the free market, will be over produced to the
extent that it gives of negative externalities
and causing markets failure)
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Taxation
1. For government to obtain funds to run the
country
- By using direct tax - eg income tax, tax on
property etc. (direct tax meaning the one has to
pay the government directly) - By using
indirect tax - eg Goods and Service Tax (GST),
Electronic Road Pricing (ERP) (indirect tax
meaning someone will pay the tax to the
government on your behalf eg. the 711 store,
petrol station etc.
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Taxation
Demerit goods like cigarettes and alcohol affect
the environment negatively as well as give rise
to social ills. Because of this, the government
needs to reduce their consumption (ie. reduce
their quantity demanded.
P
How Taxes reduce demand for a demerit
good Assuming that the initial market
equilibrium (E0) the market clearing price and
output is P0 and Q0 respectively. When an
indirect is applied (eg. GST), this will increase
the cost of production of a firm. (or a
producers). As such, owing to the tax, the supply
curve will shift leftward from S0 to S1 as now
less is being produced at every price level owing
to the tax. Owing to the tax, the prices will
increase from P0 to P1 and output will be cut
back from Q0 to Q1. With a tax, the government
objective of reduction of the demerit good is
achieved as its consumption is now decreased from
Q0 to Q1.
S1
S0
E1
P1
E0
P0
D
Q
Q0
Q1
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Taxation
Amount of tax as represented in the diagram.
P
S1
S0
Amount of Taxation on each unit of the good eg.
Cigarettes P1 P2 Total Amount of Taxation on
the good is Area P1P2ZE1
E1
P1
E0
P0
D
P2
Z
Q
Q0
Q1
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Taxation
3. For the re-distribution of wealth. - The
difference in incomes between the highest earners
and lowest earners in a country is called the
income gap. - If the income gap is too wide,
this means that the rich are getting richer and
poor are getting poorer. The governments needs to
ensure that the peoples incomes are as
equitable as possible so that they poor will not
be exploited. - Taxes have the ability to take
some from the richer to help supplement the
poorer peoples income.
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subsidies
Subsidies are given to help promote the
consumption or production of a merit good that
gives off positive externalities to society.
A merit good is a good that when left to the free
market will be under consumed or underproduced.
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Subsidies
Demerit goods like cigarettes and alcohol affect
the environment negatively as well as give rise
to social ills. Because of this, the government
needs to reduce their consumption (ie. reduce
their quantity demanded.
P
How subsidies increase demand for a merit
good Assuming that the initial market
equilibrium (E0) the market clearing price and
output is P0 and Q0 respectively. When a
subsidy is given, this will reduce the cost of
production of a firm. (or a producers). As such,
owing to the subsidy, the supply curve will shift
rightward from S0 to S1 as now more is being
produced at every price level owing to the
subsidy. Owing to the subsidy, the prices will
decrease from P0 to P1 and output will be
increase from Q0 to Q1. With a subsidy, the
governments objective of increasing of
comsumption of a merit good is achieved as its
consumption is now increased from Q0 to Q1.
S0
S1
P0
P1
D
Q
Q1
Q0
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Subsidies
Amount of subsidy as represented in the diagram.
P
S1
Z
P2
S0
E0
Amount of Subsidy for each unit of the good. Eg.
H1N1 Vacination P2 - P0. Total Amount of
subsidy is Area P2P0E1Z
P1
E1
P0
D
Q
Q1
Q0