Question

CHAPTER 6: TAXES AND SUBSIDIES 1. What is the purpose of a tax? Whas dous imposing a tax do to your behavior? What is the tax wedge? Be able to use it to determine the impact of a tax on a given market. Especially as it pertains to the price paid by the buyer and the price received by the seller. 3. If a tax is imposed, say on chewing gum, be able to show/understand how it affects the market for chewing gum relative to the market solution without a tax 4. If a tax is imposed, be able to measure/describe how much revenue the government gets. 5. If a tax is imposed, it imposes a deadweight loss on society. What is a dead weight loss? Be able to measure it using a demand and supply model. 6. What is the rule of thumb regarding the imposition of a tax and who bears the brunt of the tax? Remember, it has to do with the relative elasticity of the demand and supply curves. 7. What is the purpose of a subsidy? What does granting a subsidy do to your behavior? 8. How does granting a subsidy generate a deadweight loss on society? 9. How is determining who gains the most from a subsidy related to the elasticity of demand and supply for the good being subsidized? 10. How can subsidies affect other markets? Think ethanol, corn and Coca-Cola.

Answer 1

1) Taxation has four main purposes or effects:

• Revenue,
• Redistribution,
• Repricing, and
• Representation.

The main purpose is revenue: taxes raise money to spend on armies, roads, schools and hospitals, and on more indirect government functions like market regulation or legal systems. This is the most widely known function, that is, to raise revenue for government expenditures.

Taxes directly affect the prices of goods, which affect quantities demanded due to behavioral responses, which, in turn, indirectly affect the price of other goods. Imposing taxes on any product or activity makes it less attractive and gives people less incentive to purchase or participate in it.

When sales tax rates are high, consumers spend more money on taxes and have less to spend on additional goods.
Taxation tends to influence the decision of businesses at all levels, it affects their financing decision, investment decision and dividend decision. High taxes can influence business decisions in several ways: they can reduce the number of business births by discouraging those who might otherwise form new businesses.