(a) Explain the following types of taxes: i. specific tax ii. value-added tax (bi) With the aid of diagrams, describe the effects of an indirect tax on a co...

Answer Details

(a) Types of Taxes:

1. Specific Tax: A specific tax is a tax that is fixed and imposed on a particular commodity regardless of its price. It is usually imposed as a fixed amount per unit of the commodity. For example, a government may impose a specific tax of $2 per unit of cigarette sold.
2. Value-added Tax (VAT): A value-added tax is a tax that is imposed at each stage of production and distribution of a commodity. It is calculated as a percentage of the value added at each stage of production or distribution. For example, if a manufacturer produces a shirt and sells it to a retailer for $10, and the VAT rate is 10%, the manufacturer will pay $1 as VAT. When the retailer sells the same shirt to a customer for $20, the retailer will collect $2 as VAT ($20 x 10%).

(bi) Effects of Indirect Tax on Commodity when Demand is Perfectly Inelastic:

When demand is perfectly inelastic, a change in price does not affect the quantity demanded. Therefore, the imposition of an indirect tax on the commodity will not affect the quantity demanded. The entire burden of the tax will be borne by the consumer, and the price paid by the consumer will increase by the full amount of the tax. The diagram below illustrates the effects of an indirect tax on a commodity with perfectly inelastic demand.

the demand curve is perfectly vertical, and the supply curve shifts upward to represent the tax. The vertical distance between the old and new supply curves represents the tax, and the entire burden is paid by the consumer as the price paid increases by the full amount of the tax.

(ii) Effects of Indirect Tax on Commodity when Demand is Perfectly Elastic:

When demand is perfectly elastic, a small increase in price will cause the quantity demanded to fall to zero. Therefore, the imposition of an indirect tax on the commodity will result in the entire burden of the tax being borne by the supplier. The price paid by the consumer will remain the same, and the supplier will have to bear the full amount of the tax. The diagram below illustrates the effects of an indirect tax on a commodity with perfectly elastic demand.

the demand curve is perfectly horizontal, and the supply curve shifts upward to represent the tax. The vertical distance between the old and new supply curves represents the tax, and the entire burden is paid by the supplier as the price received remains the same.