Taxes and subsidies
Indirect taxes
- An indirect tax (on spending) raises a firm's costs, shifts supply left, raises the price and cuts the quantity.
- Used on demerit goods and negative externalities.
- Incidence (who really pays) depends on elasticity:
- demand inelastic → consumers pay most,
- demand elastic → producers pay most.
Practice
An indirect tax on a good shifts the supply curve:
A tax raises costs, shifting supply left — price up, quantity down.
Practice
If demand is inelastic, most of an indirect tax is paid by:
With inelastic demand the price rises by nearly the full tax, so consumers bear most of it.
Subsidies
- A subsidy (payment to producers) lowers costs, shifts supply right, lowers the price and raises the quantity.
- Used for merit goods and positive externalities.
Practice
A subsidy to producers is typically used for:
Subsidies encourage merit goods and goods with external benefits by lowering their price.
You've got it
Key idea
- an indirect tax shifts supply left (price up, quantity down) — used on demerit goods
- tax incidence: inelastic demand → consumers pay; elastic → producers pay
- a subsidy shifts supply right (price down, quantity up) — used for merit goods