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This chapter analyzed the welfare effects of a tax on a good. Now consider the opposite policy. Suppose that the government subsidizes a good: For each unit of the good sold, the government pays $2 to the buyer. How does the subsidy affect consumer surplus, producer surplus, tax revenue, and total surplus? Does a subsidy lead to a deadweight loss? Explain.

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Essentials of Economics (MindTap C...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781337091992

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Section
BuyFindarrow_forward

Essentials of Economics (MindTap C...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781337091992
Chapter 8, Problem 8PA
Textbook Problem
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This chapter analyzed the welfare effects of a tax on a good. Now consider the opposite policy. Suppose that the government subsidizes a good: For each unit of the good sold, the government pays $2 to the buyer. How does the subsidy affect consumer surplus, producer surplus, tax revenue, and total surplus? Does a subsidy lead to a deadweight loss? Explain.

To determine

The impact of subsidy on the commodity.

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. When there is a tax, it will lead to fall in the consumer surplus as well as in the producer surplus. As a result, the total surplus which is the summation of the consumer surplus and the producer surplus will fall and this fall will occur in the total surplus due to taxation which is known as the deadweight loss due to tax.

The equilibrium price is determined by the demand for the coat and the supply of coat normally. The consumer surplus can be explained as the difference between the highest price that the consumer is willing to pay and the actual price that the consumer pays. The difference between these two prices is known as the surplus to the consumer. The producer surplus is the difference between the minimum willing to accept price by the seller and the actual price that the seller receives for the commodity.

When there is no subsidy in the economy, the economy will be in its equilibrium which will be determined at the intersection of the demand curve and the supply curve in the economy. Thus, the equilibrium price will be P1 and the equilibrium quantity will be Q1. When the subsidy is introduced in the economy, consumer pays less than the equilibrium price and the producer receives more than the equilibrium price because they receive the subsidy of $2 for every commodity sold...

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