Chapter 8, Problem 1QR

To determine

The impact of tax on consumer and producer surplus and tax revenue.

Explanation of Solution

The tax is the unilateral payment from the people to the government. Tax is the main source of income of the government which can be used for carrying on the public expenditure of the government. The main types of taxes include the income tax, wealth tax and the professional tax which constitutes one-third of the total tax revenue of the government. The consumer surplus is the difference between the maximum price a person is willing to pay and the actual price he paid.  Similarly, the producer surplus is the difference between the minimum price a producer is willing to accept and the actual price he received.  The aggregate of these two surpluses is known as the economic surplus.

When there is a tax imposed on a commodity, the price of the commodity will increase because the price is the means through which the sellers transfer the impact of tax from them to the consumer. Thus, with the tax imposed on a commodity, the price of the commodity will increase and as a result, the price that the consumer pays will increase and the price that the producer receives declines. As a result, the decline in the consumer and the producer surplus will become more than the tax revenue collected by the government which will decline the total surplus of the economy. Thus, tax disincentives the buyers and sellers and as a result there will be inefficient allocation of resources in the economy.

Economics Concept Introduction

Concept introduction:

Tax: It is the unilateral payment made by the public towards the government. There are different types of taxes in the economy which includes the income tax, property tax and professional tax etc.

Consumer surplus: It is the difference between the highest willing price of the consumer and the actual price that the consumer pays.

Producer surplus: It is the difference between the lowest willing to accept price by the producer and the actual price received by the producer.

Deadweight loss: It is the reduction in the units where the marginal benefit to the consumer is higher than the marginal cost of production of the unit.