The paper "Economics and Development" is a wonderful example of an assignment on macro and microeconomics. a) Based on the information provided, advise the Minister which one of the two products she should tax. Explain and justify your advice. Taxation is one source of government revenue, there exist two types of taxes which are direct taxes and indirect taxes, direct taxes are those taxes that are imposed directly on products or even personal income tax. Indirect taxes are taxes imposed on goods and services. When a direct tax is imposed then both the sellers of the products and the buyer faces the burden of the tax. On the decision to decide which product to impose the tax we will have to consider the incidence of tax and this will be determined by the elasticity of demand.
Because the country has no indirect tax then that’ s why the indirect tax is preferred, the effect of an indirect tax on a good is demonstrated below: When the tax is imposed on the seller then the price rises and this is shown in the diagram where the price moves from P to P+T, these price increases shift the supply curve upwards from supply curve 1 to supply curve 2 as shown above. When we have a perfect inelastic demand curve then the tax burden is wholly transferred to the buyer, however, if we have a perfectly elastic demand curve then the tax burden is to the seller or producer. Concerning supply when we have a perfectly inelastic supply curve then the tax burden is to the seller, and when we have a perfectly elastic supply curve then the tax burden is to the buyer. A tax will lead to a reduction in the producer surplus and at the same time the consumer surplus, further, the tax also results to deadweight loss, the diagram below shows the consumer surplus and the producer surplus: From the above diagram, it is clear that the producer surplus is reduced and also the consumer surplus, the loss in consumer surplus and producer surplus goes to the tax and also the deadweight loss.
Therefore a tax will lead to a loss which is referred to as the deadweight loss.
The deadweight loss is the value that is lost as producer surplus and consumer surplus and also it is not collected by the government as tax.
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