Indirect Tax and Market Outcomes
A diagram showing the effects of an indirect tax on a market, resulting in a leftward shift of the supply curve, higher price for consumers, lower quantity traded, and a reduction in market efficiency.
demand
Demand Curve: Downward-sloping, showing the inverse relationship between price and quantity demanded.
original supply
Supply Curve: Upward-sloping, representing the pre-tax quantity producers are willing to supply at each price.
new supply
Supply + Indirect Tax: The new supply curve after a per-unit tax increases production costs.
price effect
Price Effect: Consumers face a higher price (P+t), depending on the tax incidence.
quantity effect
Quantity Effect: Quantity falls from Qe to Q+t, reducing market efficiency.
An indirect tax is a tax imposed on goods or services, typically paid by producers but passed on to consumers through higher prices.
The tax shifts the supply curve upward (or to the left), from 'Supply' to 'Supply + Indirect Tax'.
At the new equilibrium, the price consumers pay rises from Pe to P+t, while the quantity exchanged falls from Qe to Q+t.
The vertical distance between the original and new supply curves represents the tax per unit.
While indirect taxes raise government revenue and can help internalize externalities (e.g. cigarette or carbon taxes), they may also reduce consumer and producer surplus and cause welfare loss.
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