TAXATION AND SUBSIDY

1. A charge placed on the production of a good and service by the Government. For example petrol is taxed heavily by the Government TAXATION AND SUBSIDY TAX • A charge placed on the production of a good and service by the Government. For example petrol is taxed heavily by the Government • A tax will increase the cost of production to the producer. It is makes it more expensive to produce • Impact : A marginal tax on the sellers of a good will shift the supply curve to the left until the vertical distance between the two supply curves is equal to the per unit tax; when other things remain equal, this will increase the price paid by the consumers (which is equal to the new market price), and decrease the price received by the sellers.

2. An illustration • The effect of this type of tax can be illustrated on a standard supply and demand diagram. Without a tax, the equilibrium price will be at Pe and the equilibrium quantity will be at Qe. • After a tax is imposed, the price consumers pay will shift to Pc and the price producers receive will shift to Pp. The consumers' price will be equal to the producers' price plus the cost of the tax. Since consumers will buy less at the higher consumer price (Pc) and producers will sell less at a lower producer price (Pp), the quantity sold will fall from Qe to Qt.

3. (a) Ad Valorem TaxThis is a tax based on value or price. So the higher the price the higher the tax.

4. ( b) Specific or unit taxThis tax is based onthe quantity sold. That is why it is per unit, not based on the value. .

5. Example : Demand function : P = 15 – Q Supply function : P = 3 + 0.5 Q Tax = 3 per unit What is the P and Q and the equilibrium before and after taxation Solution : Pre - tax  - the equilibrium : D=S  Pe = 7 , Qe = 8 - supply function : P = 3 + 0.5 Q Post - tax  - the price would be higher - supply function changes anad the curve moves upward - P’ = 3 + 0.5 Q’ + 3 = 6 + 0.5 Q’  Q’ = 2P’ – 12 The demand is fixed  P = 15 – Q  Q = 15 - P The market equilibrium  15 – P = 2P – 12  P = 9 ; Q = 6 So post - tax : P’e = 9 ; Q’e = 6

6. Qs Post- tax 9 ....................... E’ Qs Pre - tax 7 ............................ ... E 3 Qd Q Burden of tax on consumer : tC = 9 – 7 = 2 per unit = 67% Burden of tax on the seller/producer : tP = t – tc = 3 – 2 = 1 = 33% (less than consumers’ burden)

7. The tax received by the government (the government’s revenue) : T = # unit sold post-test * tax per unit = Q’e * t = 6 * 3 = 18 ( that’s why tax is governments’ sumber pendapatan) ----------------------------------------------------------------------------------------------------!!! Graphically, there are three ways to determine the tax’s effect: • Shift the supply curve up by T • Shift the demand curve down by T • Use a wedge between the amounts consumers pay and firms receive

8. PROPORTIONAL TAX / Ad valorem tax - is a tax based on a certain percentage of the price, not specific - the same effect , but different analysis Supply : P = a + bQ  Q = - a/b + 1/b P Say, proportional tax is 1% of price P = a + bQ + tP ( t is prop tax in %) P – tP = a + bQ (1-t)P = a + bQ P = a/(1-t) + b/(1-t) Q  Q = -a/b + (1-t)/b P

9. Use the same example Demand function : P = 15 – Q Supply function : P = 3 + 0.5 Q The tax from the government is 25% to the selling price What is the equilibrium price and the amount ( no tax and with taxation ) Solution : Pre – tax  Pe = 7 , Qe = 8 The demand is fixed, but the supply is after taxation with t = 25% P = 3 + 0.5 Q + 0.25 P  0.75 P = 3 + 0.5 Q  P = 4 + 2/3 Q Q = -6 + 1.5 P Price equilibrium  Qd = Qs 15 – P = -6 + 1.5 P  P = 8.4 Q = 6.6 So, after proportional tax, P’e = 8.4 and Q’e = 6.6

10. The tax received by the government per unit is t * P’e= 0.25 * 8.4 = 2.1 Burden of the tax on consumer : tC = P’e – pe= 8.4 – 7 = 1.4 ( 67% ) Burden of the tax on producer : tP = t – tC= 2.1 – 1.4 = 0.7 ( 33% ) The goverment’ revenue : T = Q’e * t = 6.6 * 0.25 = 1.6

11. supply a certain good or service. For example an important bus route SUBSIDYA subsidy is the opposite of a tax used by the government to encourage certain industries and products. A subsidy has the effect of shifting the supply curve to the right. This is a payment of money by the Government to a producer in order to encourage them to produce or supply a certain good or service. A subsidy will reduce the cost of production to the producer. It makes it cheaper to produce.

12. SUBSIDYA subsidy is the opposite of a tax used by the government to encourage certain industries and products. So, a subsidy is a payment to the producer per unit of production--it works exactly like the excise tax but in reverse A subsidy has the effect of shifting the supply curve to the right. This is a payment of money by the Government to a producer in order to encourage them to produce or supply a certain good or service. A subsidy will reduce the cost of production to the producer. It makes it cheaper to produce. Price that seller “sees” subsidy S p } S’ p’ Price that buyer “sees” D

13. Marginal subsidies on production will shift the supply curve to the right until the vertical distance between the two supply curves is equal to the per unit subsidy; when other things remain equal, this will decrease price paid by the consumers (which is equal to the new market price) and increase the price received by the producers. • Similarly, a marginal subsidy on consumption will shift the demand curve to the right; when other things remain equal, this will decrease the price paid by consumers and increase the price received by producers by the same amount as if the subsidy had been granted to producers. However, in this case, the new market price will be the price received by producers. • The end result is that the lower price that consumers pay and the higher price that producers receive will be the same, regardless of how the subsidy is administered.

14. The effect of the subsidy to the equilibrium - subsidy as a negative tax - the effect to the product : selling price is decreased - the market equilibrium ia less than that before / no subsidy Pre-subsidy  supply function : P = a + bQ Post-subsidy  - “ - P’ = a + bQ – S = ( a – s ) + bQ so the equilibrium point is lower Why would a government subsidise a product? • Protect jobs • Win votes • Good for the environment • Improves people‘s health • Protect a lifestyle (farming, fishing)

15. Teladan Demand function : P = 15 – Q Supply function : P = 3 + 0.5 Q The subsidy given by the government is 1.5 to the goods What is the equilibrium (no subsidy and with subsidy) Solution : No subsidy  Pe = 7 , Qe= 8 ( as been done before) With subsidy  selling price decreased, supply functin is changing and the curve is downward Supply no subsidy  P = 3 + 0.5 Q Supply with subsidy  P = 3 + 0.5 Q – 1.5 = 1.5 + 0.5 Q  Q = -3 + 2 P

16. The equilibrium after subsidy : Qd = Qs 15 – P = - 3 + 2P 18 = 3P  P = 6 Q = 15 – P = 15 – 9 = 6 Hence, with a subsidy  P’e = 6 and Q’e = 9 P Qs (no subsidy) 7 ..................... E Qs (with subsidy) 6 ............................... E’ 0 8 9 15 Q

17. The subsidy received by consumer A subsidy given by the government causes production cost is less than the real cost The difference between the real cost and the production cost is the subsidy received by the producer As a production cost is decreased, the selling price would be decrease as well and part of it received by the consumer (= SC) SC = Pe – P’e Subsidy received by the producer : SP = S – SC Subsidy given by the government : S = Q’e * s

18. TASK 3 Send me your homework before Friday - Dec. 2nd,2011 - 07.00 Find simple examples (two of each) about taxation and subsidy - explain what the problem is and what is the solution - draw the lines based on your problem (s) you can discuss it with your friend(s) about the problems so that I would receive different problems to different students