Explain on which goods and services the government should impose indirect taxes to ensure that the

incidence of the tax falls mainly on consumers and discuss the extent to which consumer surplus
would be affected. (12)

Indirect taxes are taxes which are imposed on goods and services when people buy them. They are
taxes on spending, for example, Value Added Tax (VAT). When a tax is imposed, this leads to an
increase in cost of production. The indirect tax will shift the supply curve to the left. Therefore, the
effect of imposing a tax is to shift the supply curve to the left and to decrease the quantity
demanded on the market.

However, the incidence of the taxation depends on Price Elasticity of Demand (PED) and Price
elasticity of supply. If the aim of the government is to ensure that the tax falls mainly on consumers,
it will have to impose indirect taxes on goods having

(I)inelastic demand, or

(ii)elastic supply

The tax is represented by MT. Out of MT tax, consumers pay XT, and the remaining MX tax is paid by
the producers. Therefore, tax burden falls mainly on consumers. Goods having inelastic demand
include necessities such as salt and staple food. The more inelastic is demand, the bigger proportion
of tax is paid by the consumer.

Goods having elastic supply include t-shits and cars. As price rises it is easier for producers to
increase supply. Thus, the burden will de shifted mainly on consumers.
The concept of consumer surplus will be affected by the imposition of an indirect tax. Consumer
surplus refers to the difference between what an individual consumer is willing to pay and what he is
paying.

Total consumer surplus before taxation is PDE.

Total consumer surplus after taxation is P1DE1.

Consumer surplus is reduced after the indirect tax is implemented since consumers are paying
higher and quantity consumed is lower.