3.

Government Microeconomic Intervention Pt 3

 Objectives

• Incidence of tax
• State & explain different types of taxes
 Key terms

1. Market failure: where the free market does not make the best use of
scarce resources.

2. Regulation: various means by which governments seeks to control

production and consumption.

3. Direct provision of goods: is when government supplies goods and

services such as education, health and housing.

4. Rationing: is the controlled distribution of scarce resources, goods,

services.
 Lets calculate Incidence of tax
In the diagram, demand is price inelastic. A tax of $6 causes the
price to rise from $10 to $14.

Calculate

1. Total tax revenue:

2. Tax paid by consumers:
3. Tax paid by producers:
4. Total expenditure:
5. Total firm revenue:
 Lets calculate Incidence of tax

In the diagram the demand is price elastic. There is only a

small rise in price and a bigger percentage fall in demand.

Calculate

1. Tax rate:
2. Total tax revenue:
3. Tax paid by consumers:
4. Tax paid by producers:
5. Total expenditure:
6. Total firm revenue:
 Ad Valorem tax graph

Since the tax is a percentage of the cost of the good, the absolute value
of the tax increases as the price of the good increases. For example,
with VAT at 10%, a good costing $10 will have $1 of tax. A good
costing $100 will have $10 of tax. This causes the supply curve to pivot.
 Types of Tax

Progressive Proportional Regressive

 Proportional tax

A proportional tax means different income levels pay the same % of

income in tax.

Examples
• The government charges a
flat rate of 10% on the
income earned by its citizens.

• If a person earns $10,000 he

needs to pay a tax of $1000

• If a person earns $100,000 he

needs to pay a tax of $ 10,000

The aim of Proportional tax: is that since everybody is equal,

taxes should also be charged the same way.
 Progressive tax
A progressive tax takes a higher percentage of tax from people with
higher incomes. It means that the more a person earns, the higher his
average rate of tax will be.

Examples

• In this case, the person

earning £10,000 is paying
20% of their income in tax
(total tax of £2,000)

• The person earning £20,000

is paying 30% of their income
in tax (total tax of £ 6,000)

The aim of a progressive tax is: To reduce inequality

 Regressive tax
A regressive tax is a tax which takes a higher percentage of tax revenue
from those on low incomes. As income increases, the proportion of
your income paid in tax falls.

Examples

Suppose there is a Tobacco tax of IDR 3,000

In this case, the person earning

IDR 30,000 is paying 10% of their income in tax.

Someone earning IDR 100,000 would pay

just 3.33% of their income in tax.

The aim of a regressive tax is: To reduce demand for demerit goods
Practice your knowledge
 Average Vs Marginal tax rates

The average tax rate is the total amount of tax divided by total
income.

The marginal tax rate is the amount of additional tax paid for
every additional dollar earned as income..