A Level Economics AQA Practice Exam

What does indirect taxation do to the supply curve?

1. It decreases production costs for firms

2. It creates a horizontal shift to the right on the supply curve

3. It shifts the supply curve vertically upwards

4. It has no effect on the supply curve

The correct answer is: It shifts the supply curve vertically upwards

Indirect taxation typically refers to taxes levied on goods and services, such as VAT or excise taxes. When an indirect tax is imposed, firms face higher costs of production because they must pay the tax amount. Consequently, this increases the overall cost of supplying goods to the market. The correct response indicates that the supply curve shifts vertically upwards. This vertical upward shift represents the increase in costs for producers, which leads to a decrease in the quantity supplied at any given price level. Essentially, firms will supply less at each price because the added tax represents an extra burden on their production costs. As a result, the supply curve is not moving along the curve but rather shifting to a position that reflects the higher cost of supplying the same quantity of goods. Therefore, when an indirect tax is applied, the market supply curve is adjusted to highlight this increase in costs, effectively leading to the upward shift you would observe in the new supply curve.