Question #3: Differentiate between a specific and an Ad Valorem tax.

Compare the effect of

a specific and an Ad Valorem tax on market equilibrium of (i) a perfectly competitive firm
and (ii) a monopolist.

Specific tax Ad valorem tax

1. A specific tax is a fixed amount of
tax placed on a particular good. It is
also referred to as a per-unit tax,
and the tax will depend on the
quantity sold (not price).
2. Examples of specific taxes
 A tax of £3.92 per 20 pack of
cigarettes.
 A tax of £0.75 per liter of petrol.
A specific tax does not vary with the cost
of the good
3. A specific tax is effective at
reducing demand. For example,
cigarette tax has steadily
contributed to reducing cigarette
consumption in past few decades.
An ad valorem tax imposes a tax on a
good or asset, depending on its value.
The tax is usually expressed as a
percentage.
Examples of Ad Valorem tax
 Stamp duty
 Property tax
 Consumption tax – VAT (20%)
An ad Valorem tax places a
proportionately higher tax on expensive
goods. This can encourage consumers to
switch from expensive cigarettes – to
cheaper varieties.

4. The tax paid will be the same for An ad Valorem tax collects more tax
different income groups. So those from those consumers willing to
on low-income will pay a higher purchase more expensive varieties.
percentage of income in tax.

A tax imposed on a seller with monopoly power performs differently than a tax
imposed on a competitive industry. Ultimately, a perfectly competitive industry
must pass on all of a tax to consumers because, in the long run, the competitive
industry earns zero profits. In contrast, a monopolist might absorb some portion of
a tax even in the long run.