Consumer and Producer Surplus Difference between the maximum
Consumer and Producer Surplus
• Difference between the maximum price that a consumer is willing to pay for a good and what they have to pay • Another way to describe it is the amount a consumer saves when purchasing a good or service • The formula for CS = ½bh Consumer Surplus
• P Graphically consumer surplus represents everything between the equilibrium price for a good and the maximum a consumer is willing to pay Our graph tells us that the maximum a consumer will pay for snickerdoodles is $10 each (at this price QD = 0). CS is the triangle area between max price & equilibrium price However our equilibrium price is $4 so our consumer is going to purchase 100 snickerdoodles. The consumer is saving money on each snickerdoodle because of that lower price. Our formula tells us how much they are saving: ½ (100*6) = $300. Q Our base is 100 because it is our QD (0 100) Our height is 6 (10 -4 = 6)
• Difference between the minimum price that a producer is requires to receive for a good and what they actually are paid • Another way to describe it is the additional amount a producer earns when producing and selling a good or service • The formula for PS = ½bh Producer Surplus
• Graphically producer surplus represents everything between the equilibrium price for a good and the minimum the producer requires for a good or service Our graph tells us that the minimum a producer requires for snickerdoodles is $1. 50 each (at this price QS = 0). However our equilibrium price is $4 so our producer is going to sell 100 snickerdoodles. P The producer is earning additional money on each snickerdoodle because of that higher price. PS is the triangle area between min price & equilibrium price Q Our formula tells us how much they are earning: ½ (100*2. 50) = $125. Our base is 100 because it is our QS (0 100) Our height is 2. 5 (4 -1. 50 = 2. 5)
• Total surplus for society is the sum of consumer and producer surplus P CS PS Q
Consumer and Producer Surplus with Tax Incidence • Tax incidence is a tax imposed on a good or service by the government • Taxes are ALWAYS imposed on producers first • If they can, producers will pass as much of the tax as possible on to the consumer in the form of higher prices Ideally they would like to force consumers to pay ALL of the tax • Usually tax burden is split between consumer and producer How much of a tax each group pays will depend upon the elasticity of demand for the product The more elastic the demand, the less of the tax consumers will pay
• If demand is perfectly elastic, consumers will pay none of the tax The more elastic the demand, the less of the tax consumers pay • If demand is perfectly inelastic, consumers will pay all of the tax • • The more inelastic the demand, the more of the tax consumers pay Since most goods have only a relative elasticity, they will split tax with the producer
Tax Incidence • Taxes are a cost to producers so the supply of their good will decrease (graph moves left) • This creates a higher equilibrium price for consumers and a lower equilibrium quantity • Producers do NOT get all of the price paid by consumers – they must pay part of that to the government for the tax P Q
• After the tax, the new equilibrium price is $7 so consumers now pay $3 more than they used to. • Producers now receive $2 which is $2 less than they used to. This price is found where the new quantity crosses the original supply curve. • To find the total tax subtract the amount consumers pay ($7) from what producers receive ($2) and the tax is $5. • Of that, consumers paid $3 and producers paid $2. P Q
Taxes create deadweight loss – loss of surplus to society. It represents the amount that is no longer produced and the savings that consumers have lost and the lost revenue to producers P CS Tax revenue DWL PS Q Tax revenue is the amount of revenue the government earns off the tax. It can be calculated as Tax*Qty. If the tax is $5 and the Qty is 80 then tax revenue is $400.
Consumer and Producer surplus will always be smaller after a tax is imposed. CS and PS after Tax The loss to each is the deadweight loss.
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