<2.7.4 INDIRECT TAXES>

--DEFINITION--

INDIRECT TAXES are IMPOSED ON SPENDING to buy goods and services. They are USUALLY PAID PARTLY BY THE CONSUMER but are paid to the government by producers (firms), hence the tax is paid 'indirectly' from the consumer to the government, via the producer.

1) PROVIDE GOVERNMENT REVENUE: Indirect taxes are collected by the government in order to finance their spending. This can help REDISTRIBUTE INCOME from the rich to the poor, especially if the taxes are on luxury goods (See 'Luxury tax')

2) REDUCE CONSUMPTION OF DEMERIT GOODS: Indirect taxes on goods that are harmful to society when CONSUMED (e.g. cigarettes and alcohol) can be used to increase the costs and price of these goods so the quantity demanded will decrease.

3) REDUCE THE PRODUCTION OF DEMERIT GOODS:

3) REDUCE THE PRODUCTION OF DEMERIT GOODS: Indirect taxes on goods that are harmful to society when PRODUCED (e.g. Energy produced from burning fossil fuels which create pollution) can be used to RAISE the costs of production of these producers and reduce output.

4) REDUCE THE QUANTITY OF IMPORTS

4) REDUCE THE QUANTITY OF IMPORTS: Indirect taxes can be used to raise the price of imported goods, so consumers will buy more domestically produced substitutes in order to save jobs.

SPECIFIC TAX: This refers to a UNIT TAX, in which a SPECIFIC FIXED AMOUNT OF TAX is imposed on top of the selling price of each unit of a good sold e.g a tax of $2 per pack of cigarettes sold.

AD VALOREM TAX: This refers to a PERCENTAGE TAX, in which a SPECIFIC FIXED % OF TAX is imposed on the selling price of each unit of a good sold e.g a tax of 2% per pack of cigarettes sold.

TAX BURDEN: refers to the AMOUNT OF THE TAX PAID. It is equal to the PRICE PAID BY THE CONSUMER - THE PRICE RECEIVED BY THE PRODUCER * OUTPUT.
CONSUMER TAX BURDEN: Refers to the PORTION of the tax PAID BY THE CONSUMER. It is equal to the CHANGE IN PRICE PAID * OUTPUT.
PRODUCER TAX BURDEN: Refers to the PORTION of the tax PAID BY THE PRODUCER. It is equal to the CHANGE IN PRICE RECEIVED * OUTPUT.

When PES>PED, then CB>PB and vice versa.
Typically, the incidence, or burden, of a tax falls both on the consumers and producers of the taxed good. But if we want to predict which group will bear most of the burden, all we need to do is examine the elasticity of demand and supply.

When demand is inelastic consumers have to accept higher prices as no alternatives exist, as such the rise in price can be passed onto consumers more easily.
When demand is more elastic however consumers are able to leave the market and buy alternatives if the price rises too much hence the producer is likely to absorb the majority of the tax.

When supply is inelastic producers can not easily reduce supply and have to accept lower prices as their factors are immobile and they can't reallocate them elsewhere and therefore must absorb more of the burden as opposed to suppliers with more elastic supply curves.
As such depending on which party has the relatively larger ability to avoid the price changes (the more elastic party) the smaller the burden and vice versa.
For example a hotel faces a reatively more elastic demnd curve than its supply as such the tax would need to be absorbed more by the hotel as customers have many alternatives while the hotels can not leave the industry so quickly
Cigarettes aon teh other hand are relativey more
When demand is elastic consumers don't have to accept higher prices as alternatives exist, so too producers don't have to accept lower prices as their factors are mobile and they can reallocate them elsewhere to

--STUDY THE ANIMATION ABOVE AND COMPLETE THIS SENTENCE--

"WHEN THE PED IS GREATER/LESS THAN PES, THE CONSUMER TAX BURDEN IS GREATER/LESS THAN THE PRODUCER BURDEN, AND VICE VERSA"

a) With the aid of a diagram EXPLAIN why an INDIRECT TAX on Cigarettes will most likely result in A LARGE rise in the price for the consumer. [10]

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