Producer revenue: price received x equilibrium quantity.

Taxes are usually used to raise the equilibrium price and/or reduce the quantity consumed, while subsidies are usually given to reduce the equilibrium price and/or increase the quantity consumed.

Excise duty

• tax imposed on cigarettes and alcohol?

An indirect tax is a tax imposed by the government on producers.

• A tax increases the equilibrium price of a good or service and/or reduces the quantity consumed.
• When an indirect tax is imposed on a good or service, both producer surplus and consumer surplus decrease.
• When an indirect tax is imposed on a good or service, the producer revenue decreases.
• Whether consumer expenditure increases or decreases as a result of the tax imposed depends on the price elasticity of demand for the good or service. If PED < 1, consumer expenditure increases. If PED > 1, consumer expenditure decreases.

A subsidy is a grant given by the government to encourage the production/consumption of a good or service.

• A subsidy reduces the equilibrium price of a good or service and/or increases the quantity produced/consumed.
• When a subsidy is granted on a good or service, both producer surplus and consumer surplus increase.
• When a subsidy is granted on a good or service, the producer revenue increases.
• Whether consumer expenditure increases or decreases as a result of the subsidy depends on the price elasticity of demand (PED) for the good. If PED < 1, consumer expenditure decreases. If PED > 1, consumer expenditure increases.

Impact of Indirect Taxes on Consumers and Producers

• Effectiveness in reducing quantity of goods deemed undesirable if this is the aim of the policy : Whether the tax is effective in reducing consumption to the desirable level depends on the Price Elasticity of Demand.
• Effectiveness in raising revenue for the government if this is the aim of the indirect tax : Indirect taxes increase the cost of production of the producer and result in the supply curve shifting to the left. Hence, this will result in an increase in the equilibrium price and a fall in equilibrium quantity. Therefore, if the government’s aim is to raise revenue through taxation, they should tax goods with price inelastic demand (Figure 46)
  • Total tax revenue collected = tax per unit multiplied by the quantity traded.
• Addressing Root Cause : Taxes may not be appropriate as it may not resolve the root cause of the problem.
  • in the case of cigarettes and alcohol, tax does not solve the root cause of the issue but only targets the reduction in quantity and not the root cause of the overconsumption, e.g. lack of information of the health risks.
• xxx Side Effects : Taxes will increase the cost of production for producers and they will reduce production.
  • With the cut in production, producers will need less manpower and some workers might be retrenched. This might cause an increase in unemployment rate if many sectors in the economy are affected by this tax.
• Feasibility : It is feasible to implement taxes on various goods. There is low implementation cost involved in tax collection. With strict law enforcement mechanisms, it is not difficult to ensure compliance and successful rolling out of this policy.
• Time Lags : There is no time lag in implementing tax as it can be implemented immediately.
  • However, there may be an impact lag since demand may be price inelastic in the short run. This is because it may take some time for people to change their habits. Over time, the PED value will increase as people might have changed their consumption pattern. The fall in Quantity Demanded might be more responsive and consumption levels will then move closer to the desired level of by the government.

Impact of Subsidies on Consumers and Producers

• A subsidy is an amount of money given to the producers for each unit they sell.
• (Similar to indirect tax) given to producers to encourage the production and consumption of certain goods
  • reduces the cost of production -> supply ↑
  • Subsidies, by causing supply ↑, cause equilibrium quantity to ↑, ceteris paribus.
  • Hence, subsidies are usually implemented on goods that the government deems desirable to have ↑ consumption of (e.g. healthcare, education).
• Effectiveness : Whether the subsidy is effective in increasing consumption to the desirable level depends on the Price Elasticity of Demand (Figure 49).
  • If |PED|>1, the fall in price will lead to a more than proportionate rise in quantity demanded and the subsidy will be more effective in achieving its goal of increasing quantity to the socially optimal levels.
• Addressing Root Cause : It does not address the root cause of the problem if income is falling due to recession.
  • With the fall in income, making good cheaper does not solve the problems arising from falling incomes and rising unemployment. It is just a temporary solution while waiting for incomes to recover.
  • If the price of basic necessities goes up too high, the use of subsidy can help to reduce the prices to keep the price of necessities affordable. However, the root cause of rising prices possibly due to fall in supply as a result of poor weather conditions is not addressed.
• Feasibility : The feasibility of the policy depends on the state of government finances.
  • For countries with substantial reserves like Singapore, it is feasible to use subsidies as it does not put additional strain on government reserves.
  • However, for countries with high levels of debt, providing subsidies may not be feasible as it may put a strain on government and incur higher debt for the government (e.g. USA, Japan, PIGS-Portugal, Ireland, Greece and Spain). This will result in serious economic repercussions.
• Time lags: There may be some implementation lag as government spending may need to be discussed at length through parliamentary debate.
  • However, there may be an impact lag since demand may be price inelastic in the short run. This is because it may take some time for people to change their habits.
  • Over time, the PED value will increase as people might have changed their consumption pattern. The fall in Quantity Demanded might be more responsive and consumption levels will then move closer to the desired level of by the government.