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Economics explained


microeconomic policies

The effect of imposing a tax

The effect of imposing a tax

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Diagram 1 : The effects of imposing an indirect tax

When the government imposes an indirect tax, the supply curve shifts to the left from S to S1.

Price rises from Pe to P1 and quantity demanded and supplied falls from Qe to Q1.

Diagram 2 : Effect of a tax on the supply curve

In the context of indirect taxes, two main types are recognised. These are:

Ad valorem taxes, which are a proportion or percentage of the price charged by the retailer.

Specific taxes in the form of a fixed amount per unit purchased. These are widely used to tax fuel, cigarettes and alcohol. The tax is based on a measurable quantity, e.g. per litre or per packet of 20 cigarettes.

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