Microeconomics/The Effects of Taxation

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When a government imposes tax on particular goods, this action would have effects on equilibrium price and quantity. Basically, a tax is money collected by a government from businesses or individuals directly or indirectly against services provided to the community.

Sales Tax[edit]

A tax which we will deal in today's lecture is Sales tax or tax that occur when there is exchange of goods.

Specific Tax[edit]

Specific Tax is tax which place certain amount of 'specific' value on goods. For example, A tax of $5 is placed on every unit of quantity would mean that government get $5 for every unit traded.

Effect on Price and Quantity[edit]

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. Alternatively, a marginal tax on consumption will shift the demand curve to the left; when other things remain equal, this will increase the price paid by consumers and decrease the price received by sellers by the same amount as if the tax had been imposed on the sellers, although in this case, the price received by the sellers would be the new market price. The end result is that no matter who is taxed, the price sellers receive will decrease and the price consumers pay will increase.

Effect on Production[edit]

The taxes increase prices, making the goods more expensive to purchase for the common individuals. In economic terms, the demand for products will be reduced and the welfare of those companies producing those goods or services will also be affected as their ability to collect revenue would be limited. However, most governments know this and will try to maintain those industries by offering subsidies, and other ingenious ways of keeping the demand alive if the products are of strategic importance.

Taxation is necessary for welfare of any nation.

Ad Valorem Tax[edit]

Ad Valorem Tax is a tax based on value of goods or assets usually presented in term of percentage.


tax has an effect of reducing the consumption of goods and services as it led to an increase in the prices.

Effect on Welfare[edit]

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