1. Chapter 8: Applications of Demand & Supply
H1 ECONOMICS 2017

2. What are some of the egs of government intervention in the market?
Why do you think government intervenes
in the market?
Elicit answers from the class , can annotate on screen
Taxes, subsidies,
(start from 1:21 to 4.01)

3. Income Tax Rates in Singapore

4. The duty for premium grade petrol will be raised by 20 cents per litre to 64 cents per litre, while that of intermediate grade petrol will be increased by 15 cents per litre to 56 cents per litre.

5. The tax is likely to be between $10 and $20 per tonne of greenhouse gas emissions, which is in the range of similar carbon tax rates around the world.
It will generally be applied on the largest emitters of greenhouse gases, such as power stations and direct emitters, rather than on individual users of electricity.

7. Where does the government get $ to provide subsides?

8. Income Tax Rates in Singapore

9. Overview for today’s lesson 1 2
Govt Intervention: Indirect taxes 2
Govt Intervention: Subsidy

10. GOVERNMENT INTERVENTION
8.1
GOVERNMENT INTERVENTION
In market economies, the price mechanism typically performs the role of resource allocation.
However, government intervention may be required when there are problems of
Efficiency: When markets fail (e.g. over-consumption of demerit goods)
Equity: When there is a need for income redistribution – to ensure fairer allocation of resources 10

11. GOVERNMENT INTERVENTION Effects on Consumer, Producers, Govt
8.1
GOVERNMENT INTERVENTION
Taxes
Subsidies
Effects on Consumer, Producers, Govt

12. 8.2
DIRECT
Income
Corporate
INDIRECT
Specific
Ad Valorem
The term direct tax generally means a tax paid directly to the government by the persons on whom it is imposed.
The term direct tax generally means a tax paid directly to the government by the persons on whom it is imposed.

13. TYPES OF INDIRECT TAXES
8.2
Specific Tax
Ad Valorem Tax
A specific tax or per unit tax is a fixed amount of tax per unit of a good
E.g. Petrol tax of 20 cents per litre of petrol
It is calculated as a percentage of the sale price of a commodity e.g. 7% GST in S’pore 13

14. EFFECT OF (INDirect) TAX
8.2
EFFECT OF (INDirect) TAX
ON SUPPLY

15. 8.2
EFFECT OF TAX ON SUPPLY
Government taxes producers for the quantity sold. Producers in turn charge it to the consumers.
Hence, a tax is viewed to add to the (unit) cost of production.
Therefore, the (unit) cost of production increases which will lead to a fall in supply.

16. Effect of specific tax on supply
8.2 P
S + specific tax S
amount of
specific tax
A tax shifts the supply curve upwards by the amount of the tax per unit. O Q 16

17. Effect of ad-valorem tax on supply
8.3 P
How do you illustrate this on a dd/ss diagram?
(BEE Qns 2) O Q 17

18. Effect of ad-valorem tax on supply
8.3 P
S + ad valorem tax S O Q 18

19. The duty for intermediate grade petrol will be raised by 15 cents per litre to 56 cents per litre (levied on producers).
Qn 1: Using a diagram, explain how a rise in petrol tax duty rates affects the equilibrium price and quantity of (intermediate grade) petrol?
Qn2: Indicate the price that is received by the producer after tax.

20. Effect of a tax on PRICE and QUANTITY
8.5 & 8.7 P
S + tax
The tax per unit is represented by the vertical distance between S and S + tax.
P1 + tax S
$T per unit P2
New equilibrium price (after tax) is P2 P1
P2 - tax
New equilibrium quantity (after tax) is Q2
As H1 do not need to study Consumer and producer surplus, we explain in terms of net benefit D Q2 Q1 O Q 20

21. EFFECT OF TAX ON SUPPLY Increase equilibrium price
8.2
EFFECT OF TAX ON SUPPLY
Increase equilibrium price
Reduce equilibrium quantity

22. 8.3
Tax Impact
Vs. Tax Incidence 22

23. Who pays the tax initially? Who pays the tax ultimately?
8.3
What’s the difference ?
Tax Impact
Falls on the person when the tax is first levied (usually the producer)
Tax Incidence
Division of tax between the consumers and producers
Can be shifted to the consumers through the selling price
Who pays the tax initially?
Who pays the tax ultimately?

24. 8.3
TAX INCIDENCE
Tax incidence refers to the division of a tax between consumers and producers.
Consumers pay taxes to the extent that the price of the good increases.
Producers pay to the extent that the rise in price is not enough to cover the tax.
The amount of tax burden (incidence) producers can shift to consumers depends on the relative price elasticity of demand and supply. 24

25. Effect of a tax on PRICE and QUANTITY
8.5 & 8.7 P
S + tax
Identify the area that shows
Total Tax revenue to be collected by the govt
Tax burden (incidence) borne by consumers
Tax burden (incidence) borne by producers S A P2
$T per unit P1 B
P2 - tax C D Q2 Q1 O Q 25

26. Who will bear a higher incidence/burden of tax for goods such as cigarettes and alcohol? Why? Draw a diagram to illustrate

27. 8.5
PED & TAX INCIDENCE
The more price elastic the demand is, the greater the incidence of taxation on producers.
Intuition: The more sensitive consumers are to price relative to producers, the less burden consumers have to pay.
The more price inelastic the demand is, the greater the incidence of taxation on consumers.
Intuition: The less sensitive consumers are to price relative to producers, the more burden consumers have to pay. 27

28. Same applies to alcohol and drug addicts
8.5
Smoking is an addictive habit – demand is price inelastic and thus regardless the rise in price due to high taxes, less than proportionate smokers will quit smoking.
An increase in price for a price-inelastic demand will mean a rise in total revenue for retailers so they do not hesitate to pass on the tax in the form of higher price to consumers
Same applies to alcohol and drug addicts 28

29. PES &Tax Incidence
8.5
The more price elastic the supply is, the greater the incidence of taxation on consumers.
The more price inelastic the supply is, the greater the incidence of taxation on producers.
* Depends on how fast producers can react to a change in price * 29

30. Tax Incidence: Fig 9: Price-elastic SS
8.5
Tax Incidence: Fig 9: Price-elastic SS D
Consumer’s share of tax
Producer’s share of tax
Qty
Price
SS relatively price elastic S1
Unit tax (T) P2 Q2 S0 P1
P2 - T Q1
8.8 30

31. Tax Incidence: Fig 10: Price-inelastic SS
8.5
Tax Incidence: Fig 10: Price-inelastic SS D
Consumer’s share of tax
Producer’s share of tax
Qty
Price S1
SS relatively price inelastic
Unit tax (T) S0 P2 Q2 P1
P2 - T Q1
8.8 31

32. SS relatively inelastic
8.5
PES & Tax Incidence D
Consumer’s share of tax
Producer’s share of tax
Qty
Price Q1 P1 S0 Q2 P2
Unit tax (T)
P2 - T S1 Q1 P1 S0 Q2 P2
Unit tax (T) S1 D
Qty
Price
SS relatively elastic
SS relatively inelastic
P2 - T
8.8 32

33. 8.5
If producers can react fast to a tax, consumers will bear the burden – those with short production time, ease of accumulating inventories, ease of factor substitution 33

34. 8.5
Manufactured goods that take a long time to produce like military weapons, aircrafts etc. As they can’t react fast to changes in production cost (can’t stop production midway!), they will bear most of the burden. 34

35. General Rule: Tax Incidence
If PED = PES
The burden of tax imposed will be shared equally between the consumers and producers of the product.
If PED>PES
The burden of any tax imposed will be greater on the producers of the product than on the consumers.
If PED<PES
The burden of any tax imposed will be greater on the consumers of the product than on the producers.
8.9 35

36. Summary: Tax Consequences of a Tax
Increases the cost of production and thus shifts the supply curve upwards.
Raises the equilibrium price & lowers the equilibrium quantity exchanged.
Tax burden is usually shared between consumers and producers.
Tax incidence depends on PED & PES 36

37. 8.7
SUBSIDIES

38. 8.7
Subsidy
A per unit subsidy is a fixed amount of money given to the producers for each unit they sell.
A subsidy artificially lowers the cost of production, thus shift the supply curve downwards, i.e. increases supply.
Please draw on page 8.7
What’s the impact on eqm P, Q ?
How does it increase the income of the producers? (pls indicate in the diagram)

39. Effect of subsidy on supply
8.8
Qty
Price S1 D
Before subsidy:
Producer sells at P1 and consumer pays P1
Subsidy = vertical distance of S1 and S2
= $S B Q2 P2
P2 + S
Equilibrium moves from point A to B Q1 P1 A S2
When a subsidy is given, supply curve shifts down from S1 to S2. 39

40. Consequences of a Subsidy
8.8
Consequences of a Subsidy
Producer’s income is raised.
Consumers pay a lower price
The quantity exchanged is higher.
Drawback? Subsidy is financed by tax revenue  A transfer of income from taxpayers to producers.

41. Consequences of a Subsidy
8.8
Consequences of a Subsidy
Subsidised industries are allocated additional resources.
Drawback?

42. Consequences of a Subsidy
8.9
Consequences of a Subsidy
Strain on government budget
Budget deficit
Opportunity Costs

43. Most economists agree that fuel subsidies are a bad idea
Most economists agree that fuel subsidies are a bad idea. They promote a misallocation of resources in the economy, namely, the over-consumption of fossil fuels. They can be a burden on the public finances.
Using a diagram, explain why fuel subsidy can be beneficial to consumers and producers, but is a burden on the government [4]

44. Suggested answer:
When fuel subsidy is given by the government to the producer, it will lower the cost of production and incentive for the producers to increase the supply of fuel. [1] The total revenue that the producers receive is P1Q1. In addition, they received the subsidy amount of P1FGE1. Hence, their income would have increased to OFGQsub. [1]
Consumers benefit as they will pay a lower price of P1 instead of P0. [1]
However, the government will need to spend on subsidies, which will be the subsidy per unit x quantity (P1FGE1). [1] This add on to their government expenditure and it will be a strain on government budget [1].