Explain one reason why governments impose indirect taxes.

Indirect taxes are imposed on expenditure. They raise a firm's cost of production, which causes an upward shift in the supply curve of the firm. Indirect taxes can be specific or ad valorem: specific taxes are a fixed amount of tax imposed on a product, and ad valorem taxes are a percentage of the selling price (e.g. VAT).

Indirect taxes can be used to correct negative externalities of production and consumption. An example of this is the tax that is in place on cigarettes in the UK. Cigarettes have negative externalities of consumption: when someone smokes they have a harmful effect on those around them, as well as theirselves. If a tax is imposed then the price of cigarettes increases, as well as the opportunity cost of purchasing them. This means that a lower quantity of cigarettes will be purchased, and therefore there will be a decrease in the negative externalities associated with them.

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