a) Using diagrams explain why government place higher tax rates on products such as petrol and cigarettes. Government imposed a higher tax on petrol & cigarettes in order to reduce the consumption on it. The imposition of tax rates will cause the contraction of quantity supply on the products.
(Rilley, 2012) As shown by figure 1.1, the imposition of indirect tax by government shift the supply curve upward from S1 to S2. The price increase from P1 to P2 and the quantity supply decrease from Q1 to Q2. Hence, a higher tax decrease the quantity supply as tax increase the cost of production which discouraging producers from producing it. (Vengedasalam & Madhavan, 2007)The initial point A shows inelastic demand, petrol and cigarette are initially inelastic to consumer. Therefore, the demand for petrol and cigarette is higher as consumers are less sensitive to price. After an indirect tax is imposed, the equilibrium point moves from A to B. Petrol and cigarettes at point B are elastic. The demand for petrol and cigarette is lower as consumers are more sensitive to the price. Government place higher tax on petrol is to ease the air pollution problem. Toxic pollutant such as methane released by vehicle may harmful to human health. Since petrol is complementary goods to vehicle. Increasing in price of petrol give incentive consumer to buy hybrid car. Hybrid car release fewer emissions which prevent air pollution. Furthermore, the rising in the price of petrol increase the cost of driving, consumer may choose to take public transport instead of buying new car. This may also encourage carpooling as consumer can share their petrol fee to lower the cost. Consequently, there is obvious reduction in traffic congestion. However, government exercise higher tax on cigarettes is to reduce the production of demerit goods. As demerit goods creates negative externalities. When the production of cigarettes decrease, the price of cigarettes will rise. Consumers with lower income are unable to pay and trying to quit smoking. Consequently, the death rate caused by smoking related disease such as high blood pressure, lung cancer and coronary artery disease reduce. Meanwhile, the tax revenue collected by government can be used to finance policies which benefit public such as enhancing public transport, improving healthcare services and promoting education level. In conclusion, government place higher tax on cigarette and petrol to take care of social benefits and collect tax revenue to finance economic policies.
b) Examine the impacts of rationing on a certain consumer good. Rationing defined as an artificial control of the quantity supply on the allocation of scare resources. (The Economics Times, 2014)
Rationing can be achieved when government set a maximum price. Maximum price is effective when it has been set below the market price. Hence, price falls from P1 to P2. Shortage occurs between Q1 and Q2. Deadweight loss is shown in figure 2. Impacts arise in economy due to rationing. Assume that figure 2 is the market for rented accommodation. Government fix a maximum price for that. At a price of P1, they are a lot of homeless people who are unable to pay for rent. Government intervenes by fixing a maximum price for accommodation of P2. In short run, landholder will continue to offer Q1 of housing while the homeless people reduce as they are able to afford the lower rental price. In long run, demand is higher at P2 than at P1 and the supply is lower. Therefore, excess demand occurs between Q1 and Q2 which result in shortage. (Anderton, 2008) Consumer demand for housing at lower price is higher. Whereas, landholder will reduce their supply by selling off their properties as they make no profit from supplying at that price. A black market may develop illegally where rents are above the...
References: Anderton, A., 2008. Maximum Price. In: D. Gray, ed. Economics. 5th ed. Spain: Causeway Press, p. 112.
Rilley, G., 2012. Indirect taxation. [Online]
Available at: http://tutor2u.net/economics/revision-notes/as-marketfailure-indirect-taxation.html
[Accessed 20 October 2014].
The Economics Times, 2014. Definition of Rationing. [Online]
Available at: http://economictimes.indiatimes.com/definition/rationing
[Accessed 25 October 2014].
Vengedasalam, D. & Madhavan, K., 2007. Principles of Economics. 1st ed. Malaysia(Shah Alam): Oxford Fajar Sdn Bhd.
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