REVIEW

PART 1: MICROECONOMICS
CHAPTER 5: INDIRECT TAXES, SUBSIDIES AND PRICE CONTROLS
THEORY
1. Indirect tax 1. Taxes are:
Taxes are charges that are imposed by governments on people A. compulsory charges imposed by the state on individual
and businesses. Their main purpose is to raise finance for and firms to finance government activities
government spending and to change market prices, that is, to B. involuntary fees levied on individuals or corporations and
discourage the consumption of demerit products (the products enforced by a government entity in order to finance firms
have negative impacts on consumers). C. optional financial charges or some other types of levy
imposed upon a taxpayer (an individual or legal entity)
Direct taxes are paid directly to the government by taxpayers, by a governmental organization in order to fund various
either as individuals or companies, from their incomes. public expenditures
D. None of the above
An indirect tax is one imposed upon expenditure. It is placed 2. Which of the following are the objectives of taxation by the
upon the selling price of a product, so it raises the firm’s costs Government?
and shifts the supply curve for the product vertically upwards. A. Raising revenue for the state
Because of this shift, less product will be supplied at every price. B. To maintain economic stability
C. To remove disparities in the distribution of income
A specific tax: This is a specific, or fixed, amount of tax that is D. All of the above
imposed upon a product, for example, a tax of $1 per unit. It 3. A tax on suppliers will cause the supply curve to shift
thus has the effect of shifting the supply curve vertically A. up and to the left
upwards by the amount of the tax. B. down and to the right
C. in none of the above directions
A percentage tax (also known as an ad valorem tax): This is D. it depends
where the tax is a percentage of the selling price and so the 4. A government taxes the production of cars. What is likely to
supply curve will shift upwards, the gap between S and S +tax decrease?
will get bigger as the price of the product rises. A. the cost of supplying cars
B. the price of cars
After the tax of X per unit is imposed, the supply curve shifts C. the revenue for the government
vertically upwards from S to S+tax. The producers would like to D. the supply of cars at every price
raise the price to pass on all of the cost of the tax to the 5. The impact of the tax is:
consumers. However, at that price, there is an excess supply and A. consumers are better off
so price has to fall until a new equilibrium is reached. B. producers are better off
C. government is worse off
Taxes discourage market activity. When a good is taxed, the D. deadweight loss
quantity of the good sold is smaller in the new equilibrium. 6. When the Government impose a tax on producers, who bears
the tax burden?
Tax incidence is the division of the burden of a tax between A. consumers
buyers and sellers. Buyers and sellers share the burden of taxes. B. producers
In the new equilibrium, buyers pay more for the good, and C. depends on elasticity of supply and demand
sellers receive less. D. depends on the slope of supply and demand

The impact of taxes:

- Increase in the amount consumers pay.
- Decrease in the price sellers receive.
- Decrease in equilibrium quantity.
- Deadweight loss (which is a reduction in consumer and
producer surplus)
- Fall in firm’s revenue
- Fall in consumer surplus.
- Fall in producer surplus.
- The government is the only stakeholder that gains. They
receive tax revenue
- Society is worse off as a result of the tax, because there is
an underallocation of resources to the production of the
good

Tax and efficiency:

- If the elasticity of demand > the elasticity of supply, the
burden of the tax is borne primarily by producers.
- If the elasticity of demand < the elasticity of supply, the
burden of the tax is borne primarily by consumers.

2. Subsidy 7. Which one of the following statements about subsidies is

A per unit subsidy paid to producers lowers their costs, and
therefore their supply curves, by an amount exactly equal to the
subsidy per unit of output. It's just like a per unit tax, but works
exactly the opposite way, so subsidy is a negative tax. Subsidy is
imposed to encourage the production and consumption of merit
goods (beneficial products).
The impact of subsidy:
- Total welfare (consumer plus producer surplus) is
maximized in the free market equilibrium.
- The subsidy lowers the market price of products to
consumers, and they gain consumer surplus. Their
most likely to be correct?
A. increases the price elasticity of demand of a good.
B. leads to an increase in the output sold of a good.
C. shifts the supply curve for a good to the left.
D. leads to a rise in the equilibrium price of a good.
8. Subsidy results in:
A. an increase in price at which consumers pay
B. an increase in consumer surplus
C. a decrease in producers’ revenue
D. a decrease in producer’s surplus
 welfare increases.
- The subsidy raises the revenues of producers, and causes
their producer surplus to increase.
- The cost to the government is always greater than the
increased benefits to consumers and producers, and
therefore there is a deadweight loss in social welfare.
3. Price control:
- Maximum price (price ceiling)
Maximum price Pmax is set below the market equilibrium price
P*. This is typically developed to protect consumers. This leads
to a shortage in the market as 𝑄𝑄𝐷𝐷 > 𝑄𝑄𝑆𝑆
10. Which of the following is the most likely explanation for the
- Minimum price (price floor)
Minimum price Pmin is set above the market equilibrium price
P*. This is typically developed to protect producers. This leads
to a surplus in the market as 𝑄𝑄S > 𝑄𝑄D
9. The minimum wage is an example of
A. a price ceiling.
B. a price floor
C. a free-market process.
D. an efficient labor allocation mechanism
imposition of a price floor in the market for corn?
A. Policy makers have studied the effects of the price floor
carefully and recognize that the price floor is
advantageous for society as a whole.
B. Buyers and sellers of corn have agreed that the price
floor is good for both of them and have therefore
pressured policy makers into enacting the price floor.
C. Buyers of corn, recognizing that the price floor is good
for them, have pressured policy makers into enacting the
price floor.
D. Sellers of corn, recognizing that the price floor is good
for them, have pressured policy makers into enacting the
price floor.

Answers:

1.A 2.D 3.A 4.D 5.D 6.C 7.B 8.B 9.B 10.D
CHAPTER 5: INDIRECT TAXES, SUBSIDIES AND PRICE CONTROLS
DIGRAM AND CALCULATION
TAX

SUBSIDY
PRICE CONTROL – MINIMUM PRICE (PRICE FLOOR)
PRICE CONTROL – MAXIMUM PRICE (PRICE CEILING)

QUESTIONS:

1. When a price ceiling is imposed in a market,

A. a persistent shortage results
B. a persistent surplus results
C. sellers of the product are made better off
D. no one is made better off
E. quantity supplied is greater than the quantity demanded
2. The demand and supply for soft drinks are given by Qd = 20 – P and Qs = 3P. Calculate the deadweight loss resulting from the
taxation. Suppose now the government imposes a per-unit tax of $4 on the sellers.
A. $5
B. $6
C. $8
D. $36
 3. The diagram shows a subsidy on cotton production by the government. Which
area represents spending on the subsidy by the government?
A. ACBG
B. ACLP
C. BPFG
D. ACPF
4. In the city of Freiburg, the market for bicycles is described by the following
demand and supply equations: Pd = 25 – 2Q and Ps = 1 + Q. Suppose the
government wants to impose an specific tax on bicycles. What should the amount
of the tax be if the government wants to have 6 bicycles sold on the market after
the tax is imposed?

A. The tax should be $4 per bicycle.

B. The tax should be $5 per bicycle.
C. The tax should be $6 per bicycle.
D. The tax should be $7 per bicycle.

5. Suppose the market for corn in Urbana is as follows:

Pd = -Q + 800

Ps = Q + 100

Suppose a price ceiling of $400 per unit is imposed in this market by the government of Urbana. This will result in

A. No effect on this market since the price ceiling to be effective must be set higher than the equilibrium price.
B. No effect on this market since the price ceiling to be effective must be set lower than the equilibrium price.
C. A surplus of 100 units of corn in this market.
D. A shortage of 100 units of corn in this market.
6. Suppose the government of Urbana in question 5 sets a price floor of $600 per unit in the corn market. Assume that the
government of Urbana will purchase (and store) an amount of corn sufficient to keep the price of corn at this floor price.
Holding everything else constant and assuming that storage costs are equal to $10 per unit of corn stored, the implementation
of this price floor in the market for corn results in total costs to the government of
A. $18,000
B. $18,300
C. $180,010
D. $183,000
Answers:

1.A 2.B 3.A 4.C 5.D 6.D