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CIE3ME Chapter 1.3 Government Intervention (Indirect taxes (Effects on…
CIE3ME
Chapter 1.3 Government Intervention
Indirect taxes
Why They Are Imposed
Government revenue **taxes more likely to be imposed on goods w/ inelastic demand
Discourage consumption of demerit goods
Redistribute income
Improve allocation of resources (correcting negative externalities)
Diagrammatical Consequences
At the original equilibrium price, there is a shortage → rationing function moves price upwards to discourage demand; signalling function tells producers that more money can be made due to the rise in price, giving them the incentive to produce more, increasing QS
Steeper supply curve due to increased cost of production
New equilibrium achieved, deadweight loss created on the left of original equilibrium, rectangle b/t original equilibrium and price of new quantity on original curve is tax burden on producers; rectangle b/t original equilibrium and new price is tax burden on consumers
Depending on elasticities, proportion of burden will shift (i.e. inelastic demand will put more burden on consumers)
Effects on Stakeholders
Consumers: worse off b/c price rises, quantity consumed is less
Producers: worse off; less revenue overall
Government: better off, increased revenue
Workers: worse off; less workers required to produce good → can lead to unemployment
Society: underallocation of resources, deadweight loss
Definition: certain amount of money per unit of good sold (based on expenditure); ad valorem = percentage, specific = fixed amount
Subsidy
Price Floor
Price Ceiling
Definition: legal maximum price set for a particular good
Diagrammatical Consequences
At the price of the price ceiling, there is a shortage
Deadweight loss is on the left because less people are receiving the good at this lower price (at new price, QD> QS)
Possible Solutions
Lottery: who is randomly selected randomly allocates good
Illegal market: those who obtain the good often resell it at a higher price, at the price where the new QS is demanded
First come first serve
Historical use
Effects on Stakeholders
Consumers: those who can buy the good at the lower price are better off; others remained unsatisfied because there is not enough of the good to satisfy all demanders
Producers: small quantity sold at lower price
Workers: less quantity supplied, less workers required → unemployment
Government: may gain in political popularity for those who are better off due to price ceiling
Examples
Rent controls: houses made affordable to low-income earners