8.3 Effects of indirect taxes on price and quantity...

Indirect taxes involve shifting the payment from the taxed entity to someone, usually to the final consumers of goods. These include taxes on manufacturers, wholesalers, and retailers, which are shifted through increased prices partially or wholly to the final consumers. Good examples include value added tax, excise duties and sales taxes etc. Such taxes may attract a certain amount per unit of the commodity concerned or they may target a percentage of the final retail price (called an ad valorem tax). By altering relative prices, indirect taxes distort consumer choices. The distortion reflects the incomplete nature of most indirect taxes: a uniform tax on all goods and services would leave relative prices unchanged and avoid distortion effects. Such uniformity would be simpler to administer but would eliminate other uses of indirect taxes. In particular, indirect taxes can be used to correct market abnormalities that arise in consumption or production.

The effect of subsidy on price of good and services

Subsidy refers to a lowering of good's price with a view to changing the consumption or allocation decisions in favour of the subsidized goods.

The objectives of subsidy include:

	Inducing higher consumption/ production
	Offsetting market imperfections
	Achievement of social policy objectives

8.3 Effects of indirect taxes on price and quantity...

Subsidy could be in form of reduction of tax-liability, low interest government loans or government equity participation. For example, if government procures food grains at prices higher than market prices or if it sells the grains below the prevailing market subsidies are imposed. Subsidies can be distributed among individuals according to merit, level of income and social group.

Two common errors occur in this type of subsidy if targeting is mistakenly done. Exclusion of error which involves excluding those that deserves the subsidy. Inclusion of error refers to the including those that do not need subsidy.

Economic effects of subsidy

Allocative effects

This involves sectoral allocation of resources. Subsidies help attract more resources towards the subsidized sector.

Redistributive effects

These mostly depend upon the elasticities of demands for the subsidized good, elasticity of supply of the same good and the way of executing the subsidy.

8.3 Effects of indirect taxes on price and quantity...

Fiscal effects

Subsidies mostly emanate from the budget. Therefore, they directly increase fiscal deficits. Similarly, subsidies may indirectly affect the budget negatively by drawing resources away from tax-yielding sectors towards sectors that may have a low tax-revenue potential.

Trade effects

Subsidies regulated price and it lowers than the market clearing price significantly. Beside that, it may reduce domestic supply and lead to an increase in importation. On the positive side, subsidies may enable domestic producers to offer internationally competitive prices, reducing imports or raising exports.

When employing the service of subsidy, care has to be taken as it may lead to unintended economic effects. Subsidy may likely result to in inefficient resource allocation if use on a market that is competitive or in a situation where market imperfections do not justify the subsidy.

8.3 Effects of indirect taxes on price and quantity...