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I am working on the cost of taxation.

The market for pizza is characterized by a downward-sloping demand curve and upward-sloping supply curve.

Suppose that the govenment forces each pizzeria to pay a $1.00 tax on each pizza sold. Illustrate the effect of this tax on the pizza maarket, being sure to label the concumer suprplus, producer surplus, government revenue, and deadweight loss. How does each area compare to the pre-tax case?

I understand what has happened and I can draw the graph. The supply curve has shifted to the left from supply 1 to supply 2. I can show the the new prices, consumer, producer surplus and deadwight loss. I know the area from the new price the sellers receive the new price the buyers pay is the tax revenue paid to the government.

What is throwing me is the area that is now between the supply 1 and supply 2. I know where the deadwight loss is and I can draw and labelit. What I am not sure of if part of the shift if now part of the tax revenue? On the consumer side between supply 1 and 2 is a piece of their surplus now tax revenue? On proucer side is on piece of their surplus now tax revenue and another part just loss to the producer surplus (not deadweight loss)?

  • Economics -

    I believe I understand your question. And the answers are yes and yes.

    On your graph, the tax is represented by the area of the rectangle defined by P (paid by consumers), P (received by sellers), and the quantities 0 and Q=new equalibrium. (The difference in the two prices should be exactly $1.00. The loss in consumer surplus is the area under the demand curve and between the original price and the new price paid by consumers. As you can see, a rectangular area of this loss in consumer surplus is now tax revenue. The little triangle area outside of the tax revenue box is your deadweight loss.

    Follow the same analysis to get producer surplus and the loss in producer surplus going to tax revenue and deadweight loss.

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