http www bized ac uk Correcting Market Failure

http: //www. bized. ac. uk 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 2004 – Biz/ed

http: //www. bized. ac. uk 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 Copyright 2004 – Biz/ed

http: //www. bized. ac. uk Price Subsidies and Taxation S £ 14 £ 10 S + Subsidy Total Cost of the Subsidy Amount of subsidy per unit (£ 4) The amount of the subsidy is The First effect we look ofdistance the at the subsidy market is to the vertical between The subsidy will encourage reduce before the subsidy and increase the two prices supply curves suppliers to offer more forwhat sale amount available – but at at every price cost? £ 7 D 500 700 Quantity Bought and Sold Copyright 2004 – Biz/ed

http: //www. bized. ac. uk 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 2004 – Biz/ed

http: //www. bized. ac. uk Subsidies and Taxation • Effects of a tax: • Increases price • Reduces consumption/output • Welfare effects: – Burden of tax on producer and consumer – changes in producer and consumer surplus – Tax yield minus the cost of the tax Copyright 2004 – Biz/ed

http: //www. bized. ac. uk Subsidies and Taxation • 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 2004 – Biz/ed

http: //www. bized. ac. uk Incidence of a tax on petrol Price p per litre S + tax S Amount of tax = 3 p per litre 76. 8 Tax burden of Tax Revenue consumer 74 The Some The producer The amount of tax theeffectively tax has of the isto passed carry tax increases is the on rest to the of Petrol has an inelastic the consumer vertical burden. thedemand cost distance in With of the production an form between inelastic of higher shifting the demand two prices curve this –supply this may supply is not curves thetobe burden the very leftof much! tax Tax burden of producer D 50 49. 5 Quantity Bought and Sold (000 s litres per day) Copyright 2004 – Biz/ed

http: //www. bized. ac. uk Incidence of an ad valorem tax on a product with a greater degree of price elasticity Price S + Tax £ 9 £ 7 S Burden on Consumer Total Tax Paid Burden on Producer Amount of the tax (£ 6) D £ 3 500 900 Quantity Bought and Sold Copyright 2004 – Biz/ed