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

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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

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Specific Tax is a unit-quantity tax placed on goods. For example, a tax of $5 placed on a certain good would mean a buyer/seller pays $5 as tax to government for every unit traded.

Effect on Price and Quantity

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A marginal tax on sale of a given 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, given that other things remain equal. This will increase the market price (the price consumers buy a given good), and decrease the pay received by the sellers.

Alternatively, a marginal tax on consumption will shift the demand curve to the left, given that other things remain equal. This will increase the market price (price paid by consumers), and decrease the pay received by sellers by the same amount as if the tax had been imposed on the sellers. The end result is that no matter who is taxed, the sellers get less paid, though the consumers pay more.

Effect on Production

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Tax increases the price of a good; it makes it more expensive. In economic terms, it causes demand for a good to reduce. Also, the desire of the producers (suppliers) will not be realized (fully) as their ability to earn adequate revenue slows down. However, most governments understand the impact of tax on demand and supply, so they try to support producers by providing them some incentives. A government may also introduce subsidy to sustain demand in cases where a given good is highly essential.

Taxation is necessary for welfare of any nation.

Ad Valorem Tax

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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

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