How do higher taxes lead to a fall supply?Watch
Do they increase production costs e.g. making costs of raw materials more expensive, or, do they just reduce the incentive to supply more because a higher proportion of their profit will go the government as revenue?
Indirect taxation such as VAT on goods will shift the supply curve to the left, evidently increasing the price and reducing quantity supplied. The intuition behind this is that due to the higher price less will be demanded by consumers and so the equilibrium will be of a lower quantity, firms are unable to reduce the price to previous levels due to the cost of factors of production possibly exceeding this value. We can also see who bears the burden of the tax due to the imposition of the tax, as it reduces consumer and producer surplus. As demand becomes more inelastic the burden becomes greater for the consumer, for a perfectly inelastic scenario the entirety of the burden is accrued by the consumers, an example may include a good to where there are no substitutes so quantity never changes, an increase in price doesn't alter producer surplus as they are still earning the same amount, consumers are having to pay a higher price however.
Producers tend to suffer more when the good is demand elastic when the proportion of tax burden placed on them will be significantly greater compared to consumers.