1) Indirect taxes are imposed on expenditures and raise firms' costs, shifting the supply curve left. The tax amount is the vertical difference between the original and new supply curves. 2) Subsidies have the opposite effect of taxes by shifting the supply curve downward, lowering prices. This increases producer revenue and consumer expenditure. 3) Price controls set maximum or minimum prices, creating shortages or surpluses. Governments intervene by subsidizing production, buying excess supply, or restricting imports to maintain the control. However, this can lead to inefficiency if firms are not incentivized to reduce costs.

1. Indirect Taxes , Subsidies , and
Price Controls

2. The effect of an indirect tax on the
demand for, and supply of, a product
• Taxes and subsidies have and effect upon
demand and supply and is influenced by
relative price elasticities of the product.

3. Indirect taxes
• Indirect taxes are
imposed on expenditure.
• It raises the firm’s costs
and shifts the supply
curve to the left.
• The vertical difference
between two supply
curve measures the tax
amount.

4. The main reasons for government imposing taxes can be
To generate Government revenues: excise duties on beers, wines and spirits are price
inelastic in demand, so tax price increases by levying specific alcohol and tobacco taxes
raise consumer expenditures as a whole on these categories and therefore taxation
revenues;
To discourage consumption: Government might use taxes to discourage consumption of
certain demerit goods such as cigarettes.
To alter the pattern of consumption: Government might use direct taxes as a mean to
alter the consumption patter of its population. Certain goods can be made more price
attractive through lower taxes while goods which have high marginal social cost can be
made expensive through taxation.

5. Two types of Indirect Taxes
• A specific tax: It is a fixed amount of tax
imposed upon a product

6. Two types of Indirect Taxes
• A percentage tax(Ad valorem tax): This is a tax
imposed as a percentage of the selling price.
• As the price increase, the tax amount also will
be bigger.

7. Distinction between specific and ad
valorem taxes
Specific tax is a flat rate of tax whereas ad valorem tax is a percentage tax.
Ad valorem literally the term means “according to value.” It is imposed on the
basis of the monetary value of the taxed item.
A specific tax is when specific amount is imposed upon a good, for example $10
on each mobile phone sold; whereas ad valorem tax is expressed as a percentage
of the selling price e.g. 12% of the sales.
The amount of specific tax changes in the same proportion as the quantity sold
increase, whereas, in ad valorem the tax collected is more at higher prices then
at lower prices.

8. Producer revenue

9. What will happen to the price that the
consumer pay?

11. What will happen to the amount
received by the producer

12. Government tax revenue and tax
burden

13. Share of tax burden for consumers and
producers.
• Incidence of an
indirect tax on
consumers and
producers is greatly
influenced by the PED
and PES of the
commodity.
• Situation 1: PED
PES.

14. Share of tax burden for consumers and
producers.
• Situation 2: PES PED

15. Rules in Incidence of Indirect Tax
• 1. PED = PES Burden equally shared
between consumers and producers.
• 2.PED > PES Burden more on producers
than on consumers.
• 3. PED < PES Burden more on consumers
than on producers.

16. The effect of a subsidy on the demand
for, and supply of, a product
• A subsidy is an amount of
money paid by the government
to producers or consumers per
unit of output.
• A subsidy has an opposite effect
of a tax.
• Subsidies may be regarded as
negative indirect taxes.

17. Reasons for Subsidies
• To lower the price essential
goods. Encouraged by lower
price, consumption will be
increased.
• To guarantee the supply of
products that the govt thinks
are necessary for the economy.
• To enable producers to
compete with overseas trade
and to protect the home
industry.

18. How is it helping?
• When subsidy is granted,
supply curve will shift
vertically downwards by
the amount of the
subsidy.
• It lowers the prices.
• This is again depended
on the relative elasticities
of demand and supply.

19. Specific subsidies and percentage
subsidies
• A specific subsidy is a specific
amount of money that is given
for each unit of the product.
(eg:$3 per unit)
• A percentage subsidy is fixed on
the basis of the price of the
product. As the price increases,
amount of subsidy also increase.
• But this is very rare in practice.

20. Increase in producer revenue
• The market is in equilibrium
at Qe.
• When a subsidy of WZ per
unit is granted, supply curve
shifted from S to S-Subsidy .
• Producer lowers the price
and increase the output till
the new equilibrium is
reached at P1 price and Q1
quantity demanded and
supplied.
• Income of producer rises
from OPeXQe to ODWQ1

21. Influence of subsidies on consumer
expenditure
• Subsidies always makes
the consumer able to
spend more.
• In the diagram, as price
decreased from Pe to
P1, the consumption
expenditure increased
by QeQ1 {PED is elastic}

22. Influence of subsidies on consumer
expenditure
• In the diagram, as price
decreased from Pe to
P1, the consumption
expenditure increased
by QeQ1 {PED is
inelastic}

23. Cost of subsidy to the governement
• The total cost for the
government is the
shaded area on the
diagram[P1DWZ]
• This money has to be
taken away from
other areas or it must
raise the taxes.

24. Cautions/Pre-cautions while granting
subsidies
• The opportunity cost
involved.
• Whether subsidy will allow
firms to be inefficient.
• Subsidies are ultimately
funded by tax payer. Who is
paying the taxes?
• Whether it is causing any
damages to the foreign
producers who are not
receiving subsidies?

25. Price Controls
• The free market does not always lead to the
best outcomes for all producers and
customers, or for society. So the govt.
intervention is necessary.
• The main two interventions are through:
• Maximum prices and
• Minimum prices.

26. Maximum(low) price controls
This is a situation where
the government sets a
maximum price, below the
equilibrium price.
This prevents producers
from raising the price above
it.
This is also known as the
ceiling price.
Normally imposed when
the good is a necessity and
/or a merit good.

27. • Excess demand leads to black
market.
• The shortage of goods needs to
be eliminated.
• Two options:
• 1. Shift the demand curve to the
left.(Not a good move!)
• 2. Shift the supply curve to the
right. This can be done through:
• (a) Offer subsidies to encourage
production.
• (b) Govt directly producing
goods.
• (c ) Release the old stock.

28. Minimum(high) price controls
• This is a situation where
govt. sets a minimum
price, above the
equilibrium price.
• This prevents producers
from reducing the price
below it.
• This is also known as
floor prices.

29. Why minimum price?
• To raise incomes for
producers of goods and
service that the govt. thinks
are important.(large
fluctuations in price or lot of
foreign competition)
• Setting minimum wages
helps the workers earn a
reasonable income.

30. Maintaining minimum price through
govt. intervention
• The govt. can
eliminate the
excess supply by
buying up the
excess products at
the minimum price
and thus can shift
the demand curve
to the right

31. What the government will do with
this?
• But the govt. has to either store it or destroy
it; both are expensive
• Can sell outside?....will lead to angry reactions
from foreign govts. for dumping.

32. Maintaining minimum price through
govt. intervention
• Quota: Producers could
be limited by quotas.
Quota
• It restricts the supply at
Q1(as per the diagram)
• It would keep price at
Min P

33. Maintaining minimum price through
govt. intervention
• Govt. could attempt to
increase demand for the
product by advertising or
by restricting supplies
from abroad through
protectionist policies.

34. • But if the governments protect firms by
guaranteeing minimum prices,
• Firms will become less cost-conscious and may
lead to inefficiency.