Subsidies and taxes

Subsidies

Subsidy: money granted by the state to help an industry or business keep the price of a commodity or service low.

• Alternative to maximum or minimum prices.

DD, SS = original demand supply.Equilibrium price = P0 ; equilibrium quantity = Q0.

Government subsidises producers. New supply curve = S1S1

New equilibrium = E1

Price P1, quantity Q1. Subsidy per unit = vertical difference between SS & S1S1. At Q1 producers receive P1 plus subsidy per unit (P2 - P1).

Taxes

Tax on goods and services one of largest sources of tax revenue .

Tax can be…• percentage of price of the good or service• specific amount per unit of the product.

Before tax: DD & SSEquilibrium price = R24,00; equilibrium quantity = 150 000

28.80

Tax levied, suppliers add R8,00 to price.To receive R24,00 they plan to charge R32,00 (R8,00 to gov)

Supply curve shifts up by R8,00 at each level of production.New supply curve (after tax) = STST.

New equilibrium = E1

New equilibrium price = R28,80New equilibrium quantity = 120 000.

Price to consumer = R28,80.Amount received by suppliers = R28.80 - R8,00 (paid to gov.)= R20,80 (E2).

Tax per packet = E1 - E2. Suppliers can’t pass full tax on to consumer.

Consumers pay part of the tax (R24,00 - R20,80 = R3,20 per packet).

The burden of an excise tax is actually shared by three groups:• Consumers: have to pay more.• Suppliers: receive less for each unit sold –profits of owners lower than

before.• Employees of the suppliers –production falls (150 000 to 120 000),

fewer jobs.

Welfare implications of a specific excise tax