Taxes

http-equiv="Content-Type" content="text/html;product it is likely that the products demand
charset=utf-8">a) Based on the information provided,decreases and as a result the profits obtained by the
advise the Minister which one of the two productsproducers of these products will decline due to low
she should tax. Explain and justify your advice.demand that leads to low sales.
Taxation is one source of government revenue,Tax on Bilos:
there exist two types of taxes which are directBilos are used in almost all offices, schools and
taxes and indirect taxes, direct taxes are thosecolleges, an increase in their price will lead to a
taxes that are imposed directly on products or evennegative reaction by almost the entire population
personal income tax. Indirect taxes are taxesbecause every other person uses and purchases
imposed on good and services. When a direct tax isBilos. As a result of the tax on Bilos therefore the
imposed then both the sellers of the products andwhole population will term this tax as unpopular.
the buyer faces the burden of tax.The other negative reaction will come from the
On the decision to decide which product to imposeproducers of the Bilos, the producers will experience
the tax we will have to consider the incidence of taxa decline in sales level and therefore they will record
and this will be determined by the elasticity oflower profits. The lower profits will lead to the
demand. Because the country has no indirect taxcompanies wanting to cut off on expenses by laying
then that’s why the indirect tax is preferred,off workers, therefore in this case there will be a
the effect of an indirect tax on a good isnegative reaction that will result from the companies
demonstrated below:and also the laid off workers from these companies
When the tax is imposed on the seller then the priceas a cost reduction measure.
rises and this is shown in the diagram where the priceThe other issue is that Bilos, papers and books are
moves from P to P+T, these price increase shift thecomplementary goods, when the price of Bilos rise
supply curve upwards from supply curve 1 to supplyand their demand rise it is highly likely that the
curve 2 as shown above.demand for its complementary will also decline. For
A tax will lead to a reduction in the producer surplusthis reason therefore there will be a negative reaction
and at the same time the consumer surplus, furthercoming from the producers of books and papers
the tax also results to dead weight loss, the diagramregarding this tax. The decline in demand for papers
below shows the consumer surplus and the producerand books will lead to a decline in the profits for the
surplus:producers of these products and as a result there will
From the above diagram it is clear that the producerbe a rise in unemployment as a result of the
surplus is reduced and also the consumer surplus, theincreased lay off of these companies wanting to cut
loss in consumer surplus and producer surplus goes toon the cost of production in order to maintain high
the tax and also the dead weight loss. Therefore aprofits.
tax will lead to a loss which is referred to as theTax on cigarettes:
dead weight loss.When taxes are imposed on cigarettes the prices will
In our case we have two good to consider: bilos andrise, however because the elasticity of demand in
cigarettes, the elasticity of demand for bilos is 2.00,this case is low the demand will not decline at the
while for the cigarettes the price elasticity of demandsame rate as that for the Bilos, therefore the prices
is equal to 0.05. Given the elasticity levels then it iswill rise and demand will fall, smokers will react to the
clear that bilos have a higher elasticity level and thisprice increase while in the same case the producers
means that a change in their prices by imposing a taxwill experience a decline in profit and therefore they
will reduce the demand by a very large quantity. Forwill still have a negative reaction to the tax.
the cigarettes the elasticity level is lower andUnemployment will rise and therefore this will be an
therefore an increase in price will not reduce demandunpopular tax imposition by the government, the
by a large margin. The diagrams below show theunemployment will be caused by the cigarette
effect of a tax on the two goods:producing companies whereby they will lay off
From the above diagram it is clear that when the taxworkers in order to maintain high profits whereby
is imposed on either of the goods the level of pricethey will try to reduce the costs of production.
will raise and the supply curve shifts upward, theThe other issue regarding cigarette tax is that the
diagram assumes that the price for both goods istaxes will only target a certain group in the economy,
equal and that the tax imposed increases the price tothis target group is the smokers, this may be a tax
the same level.that will target this group of consumers only and the
The demand curve bilos is elastic while that oftaxes produced will result to the free rider effect.
cigarettes is inelastic, therefore if we choose the bilosThis means that the revenue collected will be used to
to impose the tax the incidence of tax is that theprovide public goods to the population but some of
burden will be both to the producer and thethe people who enjoy the goods will not have paid
customers, however if we choose the cigarettes thefor the taxes. Therefore the free rider effect on the
greatest burden will be on the buyers.economy will lead to negative reaction form the
The best option therefore will be to impose a tax ontarget group.
cigarettes. Cigarettes are luxuries as compared to theA positive reaction however will come from non
bilos which are more productive. The other reasonsmokers who advocate for a tobacco free economy,
why we would choose the cigarettes is that a pricethe increase in prices of cigarettes will lead to a
increase will not affect the demand for them by adecline in the number of cigarettes produced in the
greater degree as compared to the bilos.economy, as a result of this therefore there will be a
The other reason is the issue of incidence of tax, fordecline in the diseases associated with smoking and
the cigarettes the greater tax burden is to thealso some smokers will stop the habit, therefore the
buyers and for this reason we will achieve highertax on cigarettes will lead to positive vote regarding
revenue without affecting the demand in the market.the health and health expenses on the diseases and
For healthy issues this tax imposed on cigarettes willailments caused by smoking.
be viewed as a way in which we are discouragingConclusion:
people to smoke and therefore the decision toIt is clear that an indirect tax is a source of
impose tax on cigarettes will not be viewedgovernment revenue. However the decision on what
negatively by the population.product to tax must be determined with the
Further the dead weight loss in the cigarettes isconsideration of reaction from the suppliers or the
lower than the loss in the Bilos tax. Therefore itbuyers. The government has therefore to consider
would be advisable to tax the cigarettes instead ofthe incidence of tax or in other words whether the
the Bilos. For these reason therefore the proportionseller or the buyer bears the tax burden.
of tax collected with regard to the decline inIn our case it is better to tax to tax cigarettes
producer and consumer surplus is higher than whenbecause they have a lower elasticity of demand and
the Bilos are taxed, this is because the dead weighttherefore the price increase will not lead to a large
loss when we tax the Bilos is higher than when wedecline in demand than in the case of Bilos. The tax
tax the cigarettes.b) The decision to impose theburden when cigarettes are taxes is largely to the
indirect tax may still be unpopular with consumersbuyers.
and/or suppliers, depending on which product isHowever in both cases there is a possibility of
taxed; the Minister needs to be prepared for anynegative reaction by both the buyers and the sellers,
potential negative political reaction. For both products,this is because they both bear the tax burden that is
advise the Minister where potential negative reactionimposed, however negative reactions when
to the tax may come from.cigarettes are taxed is less than in the case when
The decision to impose taxes on products may resultBilos are taxed.
to negative reactions, when taxes are imposed on a