VAT Changes (Chain of Analysis)

In this short revision video we build a chain of reasoning on this question. Explain how a fall in the rate of VAT might affect businesses and consumers.

Key notes

• VAT is an indirect tax on suppliers in a market. The standard rate of VAT in the UK is currently 20% although there are lower rates. A cut in VAT is an expansionary fiscal policy.
• A fall in the standard rate of VAT to say 15% would effectively mean a fall in costs for many suppliers. They might choose to pass this on in reduced retail prices.
• If prices of goods and services fall, then the real income of consumers will increase - people will have more discretionary income to spend and therefore AD will rise.
• Some retailers might choose to take advantage of a lower % rate of VAT by keeping their prices constant and making higher profits.