Shift in Consumer and Producer Surplus 1) The government will tax a good for various reasons, resulting in a fall in equilibrium quality while the prices rise

1) The government will tax a good for various reasons, resulting in a fall in equilibrium quality while the prices rise. Could someone explain how price controls and taxes have influenced your purchasing choices?

Solution:

Governments all over the world try to keep prices low by setting maximum legal prices. A maximum legal price (price ceiling) is the highest price at which the government allows people to buy or sell a good. Price ceiling set below the market price will have a considerable impact on the market & there will shortage of goods. Because ceiling price is lower than the market equilibrium price & at that price demand will be more than the supply. However, these shortages can be rectified by rationing the goods, queuing or giving coupons to the needy peoples.

A minimum legal price (price floor) is the lowest price at which the government allows people to buy or sell a good. Price floor set above the market price will have a considerable impact on the market. A price floor set above the free market price will result in surplus because at higher prices, demand will be less than the supply.

Imposition of tax will result in higher prices & always creates a gap between what sellers receive & what buyers pay. However, both the buyers & sellers will share the tax burden. But the burden will depend on the concept of elasticity. If demand is elastic then sellers will share a larger burden & buyers will share a less burden. If demand is inelastic, then buyers will share a greater burden than the sellers.

2) Give an example of a shift in consumer and producer surplus. How did it affect the market efficiency? Please explain.

Solution:

In the free market, if imposition of any taxes changes price and quantity, then it will reduce welfare as measured by the sum of producer and consumer surplus. The tax causes welfare to decrease, even taking into account the gain in revenue the government gets from the tax. This decrease in welfare is usually referred to a deadweight loss due to the tax. It is a form of economic inefficiency because reduction in consumer and producer surplus, and the result is that less than the socially best amount of the good is produced, and it is sold at too high a price. Besides, taxes distort the allocation of resources & when tax is imposed, too little of society's resources will be devoted to the good.

The shift in the consumer & producer surplus is shown in the following figure.

After the imposition of tax, the supply is reduced to Stax & the price is increased to PD . The higher prices has resulted in the reduction of both consumer & producers surplus. The lost consumer surplus & producer surplus is termed as deadweight loss of welfare to the society due to taxes.