Taxes are a compulsory financial charge or some other type of levy imposed on a taxpayer by a governmental organization in order to fund government spending and various public expenditures. Taxes can be both indirect and direct. A direct tax is one that the taxpayer pays directly to the government. These taxes cannot be shifted to any other person or group. An indirect tax is one that can be passed on or shifted to another person or group by the person or business that owes the tax.
Taxes are placed on the price of a good or service, which leads the consumer to pay more for the good/service. Therefore, the imposition of a tax leads to an increase in the price of a good or service, making it look less attractive to consumers. Moreover, the introduction of taxes also impacts producers, as these taxes are also placed on the factors of production that are used to supply these goods and services. This would eventually increase the cost of production for firms, leading to a decrease in quantity supplied. As a whole, the introduction of a tax on a good/service would increase the market price and decrease the market quantity. As seen in figure 1, the increase in cost of production, led to a decrease in quantity supplied. This is shown through a leftward shift in the market diagram. With the leftward shift from SS to S1S1 we can see that the price increases from Pe1 to Pe2, whereas the quantity decreases from Qe1 to Qe2.
Subsidies are a form of financial aid or support extended to an economic sector, generally with the aim of promoting economic and social policy. It can also be done to ensure that a firm stays in business and to protect jobs as a whole. A subsidy is an amount of money that governments give to encourage producers and consumers to consume or produce a good or service. The amount of money is used to increase the price producers receive, while reducing the price a consumer pays for the product. Therefore, with a decrease in the price, the goods or service would look more attractive to a consumer. And with the money that producers have received they can use it to produce more goods or services. As a whole, the introduction of a subsidy would decrease the market price and increase the market quantity. As seen in figure 2, the subsidies lead to an increase in quantity supplied, which is shown through a rightward shift in the market diagram. With the rightward shift from SS to S1S1 we can see that the price decreases from Pe1 to Pe2, whereas the quantity increases from Qe1 to Qe2.
This concludes that taxes lead to an increase in the market price and decrease in market supply. This means that consumers have to pay more for a good or service due to the increase in the cost of production. On the contrary, subsidies lead to a decrease in the market price and increase in the market supply as the governmental organizations decrease the price that consumers pay through giving producers money to produce more of their goods and services.