1.2.9 Indirect taxes and subsidies Quiz: Pearson Edexcel Economics A, Unit 1

The 20 questions

1. What is the effect of an indirect tax on the supply curve?

   • It shifts the demand curve to the left by the amount of the tax, since consumers buy less at each price.
   • It shifts the supply curve to the right by the amount of the tax, since producers receive more revenue from sales.
   • It has no effect on the supply curve, since taxes only affect the price paid by consumers in the market.
   • It shifts the supply curve to the left by the amount of the tax, since each unit now costs producers more to supply.

2. What is the incidence of a tax?

   • The total amount of tax revenue collected by the government in a given period of time.
   • The rate at which a tax increases the price of a good in percentage terms for every consumer.
   • The division of the tax burden between consumers and producers, measured by how much each pays.
   • The number of units of a good sold in the market on which a tax is charged by the state.

3. An indirect tax of 2 pounds per unit is imposed on a good. The new equilibrium price paid by consumers rises by 1.20 pounds. What share of the tax do consumers bear?

   • 60 per cent, since 1.20 divided by 2 gives 0.6 of the tax paid by consumers.
   • 100 per cent, since the entire 2 pound tax is always paid by consumers in the market.
   • 40 per cent, since 1.20 divided by 2 gives the share of the tax paid by producers instead.
   • 1.20 per cent, since the share of tax paid by consumers is the price rise in pounds as a percentage.

4. An indirect tax is imposed on a good with relatively inelastic demand. Which group bears most of the tax burden?

   • Producers, since they always bear most of the tax burden regardless of the elasticity of demand.
   • The government, since it pays the tax directly to producers who then pass the cost to consumers.
   • Consumers, since they cannot easily reduce their purchases when the price rises after the tax.
   • Neither group, since indirect taxes are always shared equally between consumers and producers in the market.

5. An indirect tax is imposed on a good with relatively elastic demand. What is the likely effect on the price paid by consumers?

   • The price paid by consumers rises by a smaller amount, since producers absorb more of the tax through lower prices.
   • The price paid by consumers is unchanged, since elastic demand means the tax is fully paid by government.
   • The price paid by consumers rises by a larger amount, since consumers have no alternatives to switch to.
   • The price paid by consumers falls, since the tax reduces demand so much that prices must drop.

6. A specific tax of 1 pound per unit is imposed on a good whose original price was 5 pounds. The new price paid by consumers is 5.80 pounds. What is the price received by producers?

   • 4 pounds, since producers always receive the original price before the tax was introduced.
   • 6 pounds, since producers receive the consumer price plus the 1 pound tax per unit sold.
   • 5.80 pounds, since producers receive the same price as consumers pay after the tax in the market.
   • 4.80 pounds, since producers receive the consumer price less the 1 pound tax per unit.

7. A government raises the tax on petrol, and the tax revenue is the tax per litre multiplied by the quantity sold. What happens to tax revenue if demand is very inelastic?

   • Tax revenue falls, since the quantity sold falls by more than the tax rate rises in any market.
   • Tax revenue is unchanged, since demand elasticity has no effect on the revenue raised by any indirect tax.
   • Tax revenue falls to zero, since inelastic demand means no petrol is bought once the tax is applied.
   • Tax revenue rises, since the quantity sold falls by proportionally less than the increase in tax per litre.

8. What is the effect of a subsidy on the supply curve?

   • It shifts the supply curve to the left, since the subsidy raises production costs and firms supply less at each price.
   • It has no effect on the supply curve, since subsidies only affect the price paid by consumers in the market.
   • It shifts the demand curve to the right, since the subsidy increases consumers' willingness to buy the good.
   • It shifts the supply curve to the right, since the subsidy lowers production costs and firms supply more at each price.

9. A subsidy of 1 pound per unit is given to producers of a good. The price paid by consumers falls by 0.40 pounds. What is the share of the subsidy that goes to consumers?

   • 100 per cent, since consumers always receive the entire subsidy through a lower price in the market.
   • 40 per cent, since 0.40 divided by 1 gives the share of the subsidy passed on to consumers as lower prices.
   • 60 per cent, since 0.60 is the share of the subsidy kept by consumers through lower prices.
   • 0.40 per cent, since the share is the price fall in pounds expressed as a percentage of the subsidy.

10. A government pays a subsidy of 2 pounds per unit on 100 units of a good. What is the total cost of the subsidy to the government?

    • 50 pounds, since the quantity sold divided by the subsidy per unit gives the total cost to government.
    • 200 pounds, since the subsidy per unit multiplied by the quantity sold gives the total cost.
    • 102 pounds, since the government pays the subsidy per unit plus the quantity sold as an extra charge.
    • 2 pounds, since the government pays the subsidy only once for the whole quantity sold in the market.

11. Which area on a diagram represents the total cost of a subsidy to the government?

    • The area under the demand curve up to the new quantity, which represents the total spending by consumers.
    • The rectangle formed by the subsidy per unit multiplied by the quantity sold after the subsidy is introduced.
    • The triangle between the demand curve and the supply curve above the original equilibrium price in the diagram.
    • The rectangle formed by the original equilibrium price multiplied by the quantity sold before the subsidy.

12. A subsidy is given to producers of a good with relatively elastic supply. How is the benefit of the subsidy most likely to be shared?

    • Producers gain the entire benefit, since consumers can never benefit from any subsidy in the market.
    • Consumers gain a larger share than producers, since elastic supply means the price falls by more.
    • Consumers gain the entire benefit, since producers always keep the subsidy for themselves in every market.
    • Consumers gain a smaller share of the benefit, since producers respond strongly by increasing supply and the price falls less.

13. A government wants to subsidise a good that has inelastic demand. Which group is likely to gain most from the subsidy?

    • Producers, since inelastic demand means producers keep the entire subsidy and consumers gain nothing from it in the market.
    • The government, since subsidies raise tax revenue whenever demand for the subsidised good is inelastic in the market.
    • Neither group, since subsidies have no effect on prices or quantities when demand is inelastic in the market.
    • Consumers, since the subsidy lowers the price they pay and inelastic demand means they buy at lower price with little change in quantity.

14. Which of these best describes the welfare loss created by an indirect tax?

    • The area of producer surplus that is transferred to consumers as a result of the tax being introduced in the market.
    • The triangle showing the loss of trades that would have benefited both consumers and producers but no longer take place after the tax.
    • The rectangle showing the total tax revenue collected by the government from the sale of the taxed good.
    • The total cost of administering the tax, which the government must pay from its own budget each year.

15. Evaluate: is an indirect tax on a good always a good way for government to raise revenue?

    • Yes, because indirect taxes never affect the quantity bought, so revenue is guaranteed in every case.
    • Yes, because indirect taxes always raise more revenue as the tax rate rises in every market in the economy.
    • Not always, since the revenue depends on elasticity of demand, and a high tax can cut quantity so much that revenue and efficiency suffer.
    • No, because indirect taxes never raise any revenue, since consumers always stop buying a good once it is taxed.

16. A specific tax of 0.50 pounds per unit is imposed on a good sold at 3 pounds, with 200 units sold after the tax. What is the tax revenue?

    • 400 pounds, since 2 pounds multiplied by 200 units gives the total tax collected by government.
    • 1.50 pounds, since 3 pounds multiplied by 0.50 gives the total tax paid per unit in the market.
    • 0.25 pounds, since 0.50 pounds divided by 2 gives the revenue per unit sold in the market.
    • 100 pounds, since 0.50 pounds multiplied by 200 units gives the total tax collected.

17. An indirect tax leads to a fall in quantity demanded. Which description of the effect on welfare is most accurate?

    • Consumer surplus rises while producer surplus falls, since consumers gain when prices are higher after a tax.
    • Producer surplus rises while consumer surplus falls, since producers receive the whole tax revenue in the market.
    • Consumer and producer surplus both fall, government gains tax revenue, and a deadweight loss arises from lost trades.
    • Neither surplus changes, since taxes only transfer money from one group to another with no effect on welfare.

18. A tax on a good raises the consumer price by 0.75 pounds, with a tax of 1.50 pounds per unit. What share of the tax is paid by producers?

    • 50 per cent, since producers bear the remaining 0.75 pounds of the 1.50 pound tax.
    • 0.75 per cent, since the producer share equals the consumer price rise as a percentage of the tax.
    • 25 per cent, since producers pay only a quarter of the tax because consumers pay the rest.
    • 75 per cent, since consumers pay only 0.75 of the tax and producers pay the rest of the burden.

19. Which description best fits an ad valorem tax?

    • A tax charged as a fixed amount per unit, regardless of the price of the good sold in the market.
    • A tax charged once a year on the total income of the firm, regardless of its level of output.
    • A tax charged as a fixed percentage of the price of the good, so the amount paid rises as the price rises.
    • A tax paid only by consumers on the first unit they buy in each time period in the market.

20. A government subsidy is paid per unit produced. If the subsidy per unit is raised, with quantity unchanged, what happens to the government's total cost?

    • The total cost rises, since the subsidy per unit multiplied by the quantity sold is larger.
    • The total cost falls to zero, since higher subsidies are always paid by producers themselves.
    • The total cost is unchanged, since the government pays a fixed sum regardless of the subsidy rate.
    • The total cost falls, since a higher subsidy encourages producers to reduce the quantity they sell.

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