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The impact of taxation

Syllabus: Draw diagrams to show specific and ad valorem taxes, and analyse their impacts on market outcomes.

Ad-valorem and specific taxes will have different effects on the supply curve. First the specific tax. We know that this is a fixed amount which is why Chancellors / Treasury Ministers tend to increase these each year - if they did not they would be losing out. Since it is a fixed amount whatever the price of the good, it will shift the supply curve parallel upwards as shown in Figure 1.


Figure 1 Specific (or unit) tax

However, the ad-valorem tax is a percentage of the selling price. This means that at low prices the tax will be relatively little (10% of $1 is just 10c), but at higher prices the tax levied will be higher (10% of $10 is $1). This means that the supply curve shifts to the left and outwards as price increases. This is shown in Figure 2.


Figure 2 Ad-valorem tax