Economic News Worksheet

Prices surge in Japan due to rise in consumption tax

The consumption tax rate in Japanincreased from 5% to 8% on April 1. In response, sellershave adjusted the prices on their goods and services to reflect the increase.With the implementation of the tax rise, the spending spree (搶購熱潮) that took place before the rise has disappeared.

This rise in consumption tax in Japan is the first in the past 17 years. The aim is to improve the government’s fiscal situation. However, as the tax rise increases the prices of most goods and services, the government led by Prime Minister ShinzōAbe (安倍晉三) and firms are worried that the recovering economy may slip into recession again.

According to Dai-ichi Life Research Institute(日本第一生命經濟研究所), the tax rise means that a household with an annual income of 5 to 5.5 million yen will pay about 71,000 yen more in consumption tax per year, while a household with an annual income of 7 to 7.5 million will pay about 95,000 yen more. Although government revenue is expected to increase by 5 trillion in 2014, it is not likelythatgovernment revenue can covergovernment expenditure by 2020, which is a goal set by Abe’s government.

The last increase in consumption tax was in April of 1997. Since then, Japan’s economy entered a depression because of the impact of the Asian Financial Crisis. Hence, there was a long period of deflation in Japan.

2 April, 2014

Questions

1.Is the consumption tax a direct tax or an indirect tax? Explain.

2.‘Those who rushed to buy before the tax rise are irrational. Their behaviour is not consistent with the law of demand.’ Do you agree with this comment? Explain.

3.Whatdoyou predict about the change in income distribution after the rise in the consumption tax? Make your prediction based on the figures estimated by Dai-ichi Life Research Institute. (Hint: you may compare the proportion of the increase in consumption tax to the annual income of a household with a 5 million yen annual income and a household with a 7 million yen annualincome.)

4.Suppose Japan’s economy now faces the problem of unemployment.

a.As stated in the article, Japan has suffered from a long period of deflation.

i.With the aid of Fig.1, explain how the rise in consumption tax can raise the price level in the short run. What is the cost in the short run?

ii.Can the problem of deflation be solved in the long run? Explain.

b.As Tokyo will host the 2020 Olympic Games,the Japanese Government will increase its expenditure. With the aid of Fig.2, explain the effects on the price level and output level in theshort run and long run.

Suggested Answers

1.Indirect tax.

The consumption tax is collected from sellers and they can shift the tax burden to consumers by raising prices.

2.No. The behaviour is rational and consistent with the law of demand.

Prices of goods and services had not yet increased before the tax rise.

When people expectthe prices of goods and services to rise, they will buy earlier to avoidpayinghigher prices later.

3.The increase in the percentage of income paid as consumption tax by a household with a 5 million yen annual income = 71,000 yen / 5,000,000 yen × 100% = 1.42%

The increase in the percentage of income paid as consumption tax by a household with a 7 million yen annual income = 95,000 yen / 7,000,000 yen × 100% = 1.36%

The increase in consumption tax takes up a larger percentage of the annual income of a lower-income household than a higher-income household.

Based on these figures, it is predicted that the tax rise would make income distribution in Japan more uneven.

4.a.Students should indicate the following on the diagram:

i.Short run

Leftward shift of SRAS curve (from SRAS0 to SRAS1)

Increase in price level (from P0 to P1)

Decrease in output level (from Y0 to Y1)

ii.Long run

Rightward shift of SRAS curve (from SRAS1 to SRAS2)

Decrease in price level (from P1 to P2)

Verbal elaboration:

i.Production cost increases after the rise in consumption tax. Thus, short run aggregate supply decreases from SRAS0 to SRAS1.

In the short run, the price level increases from P0 to P1. However, output level decreases and falls further from the full employment level (Yf) to Y1 in the short run.

ii.The excess supply of resources / deflationary gap will result in downward pressure on input prices.

In the long run, input prices decrease and the SRAS will increase from SRAS1 to SRAS2. Thus, the policy will only lead to greater fluctuation in the price level and cannot solve the problem of deflation in the long run.

b.Students should indicate the following on the diagram:

Rightward shift in AD curve (from AD0 to AD1)

Increase in price level (from P0to P1)

Increase in output level (from Y0to Yf)

Verbal elaboration:

The increase in government expenditure will increase aggregate demand from AD0 to AD1.

In both the short run and long run, the price level will increase from P0to P1. The output level will increase to the full employment level.

Related concepts

1.Factors affecting demand (Chapter 4, Book 1, NSS Exploring Economics)

2.Classifications of taxation (Chapter 6, Book 5, NSS Exploring Economics)

3.Fiscal policy and its effects (Chapter 6, Book 5, NSS Exploring Economics)

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NSS Exploring Economics (Second Edition)© Pearson Education Asia Limited 2014

Economic News Worksheet