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Ch. 6 Sec. 4 - chapter 6 > Consumer and Producer Surplus...

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>> Consumer and Producer Surplus Section 4: Applying Consumer and Producer Surplus: The Efficiency Costs of a Tax chapter 6 The concepts of consumer and producer surplus are extremely useful in many eco- nomic applications. Among the most important of these is assessing the efficiency cost of taxation. In Chapter 4 we introduced the concept of an excise tax , a tax on the purchase or sale of a good. We saw that such a tax drives a wedge between the price paid by con- sumers and that received by producers: the price paid by consumers rises, and the price received by producers falls, with the difference equal to the tax per unit. The incidence of the tax—how much of the burden falls on consumers, how much on producers— does not depend on who actually writes the check to the government. Instead, as we saw in Chapter 5, the burden of the tax depends on the price elasticities of supply and demand: the higher the price elasticity of demand, the greater the burden on produc- ers; the higher the price elasticity of supply, the greater the burden on consumers. We also learned that there is an additional cost of a tax, over and above the money actually paid to the government. A tax causes a deadweight loss to society, because less
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of the good is produced and consumed than in the absence of the tax. As a result, some mutually beneficial trades between producers and consumers do not take place. Now we can complete the picture, because the concepts of consumer and produc- er surplus are what we need to pin down precisely the deadweight loss that an excise tax imposes. Figure 6-14 shows the effects of an excise tax on consumer and producer surplus. In the absence of the tax, the equilibrium is at E , and the equilibrium price and quan- tity are P E and Q E , respectively. An excise tax drives a wedge equal to the amount of the tax between the price received by producers and the price paid by consumers, reducing the quantity bought and sold. In this case, where the tax is T dollars per unit, the quantity bought and sold falls to Q T . The price paid by consumers rises to P C , the demand price of the reduced quantity, and the price received by producers falls to P P , the supply price of that quantity. The difference between these prices, P C P P , is equal to the excise tax, T . What we can now do, using the concepts of producer and consumer surplus, is show exactly how much surplus producers and consumers lose as a result of the tax. We saw earlier, in Figure 6-5 in Section 6.1: Consumer Surplus and the Demand Curve, that a fall in the price of a good generates a gain in consumer surplus that is equal to the sum of the areas of a rectangle and a triangle. A price increase causes a loss to consumers that looks exactly the same. In the case of an excise tax, the rise in the price paid by consumers causes a loss equal to the sum of the area of the dark blue rectangle labeled A and the area of the light blue triangle labeled B in Figure 6-14.
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