effects of changes in taxes on business profit
6.1.2 Effects of Government Policy – Taxes and Business Profit
What Happens When Taxes Change?
When the government raises or lowers a tax that a business must pay, it changes the cost of doing business. Think of it like a toll on a road: the higher the toll, the more it costs to get your product to customers.
- 📈 Higher taxes increase the cost of production or selling.
- 📉 Lower taxes reduce those costs.
- 💡 The effect on profit depends on how the business reacts.
Profit Formula
Profit is calculated as:
$P = R - C$
where $R$ = revenue and $C$ = total cost.
Cost Components Affected by Taxes
- Direct tax on goods (e.g., VAT, excise duty).
- Corporate income tax on profits.
- Payroll taxes on employee wages.
Example: A Café
Imagine a café that sells coffee for $5 each.
| Item | Cost ($) |
|---|---|
| Coffee beans | 1.00 |
| Water & utilities | 0.20 |
| Labor (barista) | 0.50 |
| VAT (10%) | 0.50 |
| Total Cost | 2.20 |
Profit per cup = $5.00 - $2.20 = $2.80.
If VAT Increases to 15%
New VAT = 15% of $5 = $0.75.
New total cost = $1.00 + $0.20 + $0.50 + $0.75 = $2.45.
New profit per cup = $5.00 - $2.45 = $2.55.
Profit falls by $0.25, a 8.9% drop.
Business Response Options
- 🔄 Raise price to keep profit unchanged.
- 💡 Reduce other costs (e.g., cheaper beans).
- 🚀 Increase sales volume to spread the tax cost.
Exam Tip
When answering questions on tax changes:
- Identify the type of tax (VAT, income tax, payroll).
- Show the cost calculation before and after the change.
- Explain the impact on profit and possible business strategies.
- Use clear examples and simple maths to support your answer.
Quick Quiz
Suppose a company pays a corporate tax of 20% on its profit. If its profit before tax is $10,000, what is the profit after tax?
Answer: $8,000 (since $10,000 × 0.20 = $2,000 tax, $10,000 - $2,000 = $8,000).
Revision
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