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Exam questions

Indirect taxes and subsidies: exam-style questions

Written in the style of A-level papers. 39 marks. Work on screen and open the answers as you go, or print a copy.

Section A: multiple choice

1A specific (per unit) tax on a good shifts its supply curve: [1]

  1. vertically up by the amount of the tax
  2. vertically down by the amount of the tax
  3. up, with the gap widening as price rises
  4. to become perfectly inelastic
Answer

A. Firms need the tax on top of what they needed before for every unit, so supply shifts up by the same amount at every quantity. A widening gap is an ad valorem tax.

2Most of the burden of an indirect tax falls on consumers when: [1]

  1. demand is more price inelastic than supply
  2. demand is more price elastic than supply
  3. supply is perfectly inelastic
  4. the tax is an ad valorem tax
Answer

A. Consumers who will not cut back much can have more of the tax passed on to them in a higher price.

3An ad valorem tax differs from a specific tax because it: [1]

  1. is a percentage of the price, so the tax per unit rises as the price rises
  2. is paid by consumers rather than producers
  3. shifts the demand curve rather than the supply curve
  4. is the same amount on every unit sold
Answer

A. VAT is an example. The tax per unit is larger at higher prices, so the new supply curve diverges from the old one.

4A subsidy of £2 per unit is given to producers. The market price falls from £10 to £9. Including the subsidy, producers now receive per unit: [1]

  1. £9
  2. £10
  3. £11
  4. £12
Answer

C. They receive the £9 market price plus the £2 subsidy, £11 in total: £1 more than before.

5The total cost to the government of a per-unit subsidy is: [1]

  1. the subsidy per unit multiplied by the new quantity
  2. the subsidy per unit multiplied by the original quantity
  3. the fall in price multiplied by the new quantity
  4. the rise in quantity multiplied by the new price
Answer

A. Every unit sold after the subsidy receives it, so the cost is the subsidy per unit times the new quantity.

Section B: data and short answer

Before a tax, sugary drinks sold for £1.00 a litre and 500,000 litres were sold each week in a region. The government then placed a specific tax of £0.30 a litre on them. After the tax, the price paid by consumers was £1.20 a litre and 420,000 litres were sold each week.

6Calculate the weekly tax revenue. [2]

Mark guidance
  • £0.30 × 420,000 (1 mark)
  • = £126,000 a week (1 mark)

7Calculate how much of the weekly tax revenue is paid by producers. [2]

Mark guidance
  • Producers now keep £1.20 − £0.30 = £0.90, so they bear £0.10 of the tax per litre (1 mark)
  • £0.10 × 420,000 = £42,000 a week (1 mark)

8Using the data, explain what the incidence of the tax suggests about the price elasticity of demand compared with the price elasticity of supply. [3]

Mark guidance
  • Consumers bear £0.20 of the £0.30 tax and producers £0.10 (1 mark)
  • The side of the market that is less responsive to price bears more of a tax (1 mark)
  • So demand for sugary drinks is more price inelastic than supply (1 mark)

9Draw a diagram to show the effect of the tax, labelling the share of the tax paid by consumers and by producers. [4]

Mark guidance
  • Supply shifted vertically up by the tax, parallel to the original (1 mark)
  • New equilibrium with a higher consumer price and a lower quantity (1 mark)
  • Producer price shown below the original price, the gap to the consumer price equal to the tax (1 mark)
  • Consumer and producer shares of the tax revenue rectangle labelled (1 mark)

10Explain one reason why a subsidy to producers may raise output by less than the government expects. [3]

Mark guidance
  • If demand is price inelastic (1 mark), the lower price brings only a small rise in quantity demanded (1 mark), so most of the subsidy shows up as a lower price for consumers rather than more output (1 mark). Credit other reasons, such as inelastic supply, with the same development.

Section C: extended answer

11Evaluate whether a subsidy is the best way for a government to increase the use of public transport. [20]

Mark guidance

A typical split is knowledge 6, application and analysis 6, evaluation 8; check your own board’s scheme.

Analysis could include

  • A subsidy shifts supply to the right, lowering fares and raising the number of journeys
  • Public transport has positive externalities: less congestion and pollution, so the free market under-consumes it
  • A subsidy can move consumption towards the social optimum where MSB = MSC
  • Cost to the government: subsidy per journey times the number of journeys

Evaluation could include

  • Effectiveness depends on PED: if demand is price inelastic, lower fares bring few extra journeys
  • Quality, frequency and reliability may matter more than price to drivers
  • Opportunity cost of the spending and the risk of inefficiency if operators rely on the subsidy
  • Alternatives: taxing car use, congestion charges, regulation, or direct investment in routes
  • Information gaps make the right size of subsidy hard to set

Levels

Top band: a range of points developed in full chains of reasoning, applied to the context, with judgements that are weighed and supported ("it depends on..."). Middle band: some developed chains but evaluation is one-sided or asserted. Bottom band: points listed or described without chains, little or no evaluation.

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