(a) Indirect taxes are imposed on spending (expenditure) to buy goods and services. They are paid partly by consumers, but are paid to the government by producers. It is placed upon the selling price of a product, so it increases the firm’s cost of production and shift the supply curve for the product vertically upwards by the amount of the tax. There are two types of indirect taxes: 1) a specific tax : this is a fixed amount of tax per unit imposed upon a product and 2) an ad valorem tax: this is where the tax is a percentage of the selling price. When an indirect tax is imposed on a product it affects both consumers and producers. Part of the tax is paid by consumers and another part is paid by producers. The tax burden is shared between the two. The burden of a tax is referred to as tax incidence. The allocation of the incidence, or who has a larger or smaller burden, depends on the price elasticity of demand.Price elasticity of demand (PED) is a measure of the responsiveness of the quantity of a good demanded to changes in its price. Demand is price inelastic when PED1 (but less than infinity).If a product has elastic demand, then a change in the price of the product leads to a greater than proportional change in the quantity demanded of it.
When demand is inelastic, most of the tax incidence (tax burden) is on consumers;when
demand is elastic,most of the incidence is on producers.
If a government puts a tax on a product, then its price will usually rise. This means that the
quantity demanded of the product is likely to fall and this will have consequences for
employment in the industry concerned. If the demand for the product is very elastic; then a
price increase as a result of imposition of a tax on the product will lead to a relatively large
fall in the demand for the product. Since governments are not usually keen to increase
unemployment, they normally place taxes on product where demand is...
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