I am working on the cost of taxation.
Question:
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)?
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.
I will take thus question because I don't know what is mean
When analyzing the effect of a tax on the pizza market, it's important to understand the different areas on the graph and how they relate to consumer surplus, producer surplus, government revenue, and deadweight loss.
After the imposition of the $1.00 tax on each pizza sold, the supply curve shifts upward by $1.00, resulting in a new supply curve (supply 2). This shift occurs because the sellers now have to bear the burden of the tax, which reduces their willingness to supply pizzas at each price.
On the graph, the new equilibrium price is higher than before the tax, as a result of the shift in the supply curve. The price increase is partially borne by the consumers, meaning they pay a higher price for each pizza. The difference between the pre-tax equilibrium price and the new higher price represents the tax burden on consumers.
Now, let's analyze the different areas on the graph:
1. Consumer Surplus: Consumer surplus is the area below the demand curve and above the pre-tax price, up to the new higher price post-tax. After the tax, consumer surplus decreases because consumers now have to pay a higher price for pizzas.
2. Producer Surplus: Producer surplus is the area below the pre-tax price and above the supply curve. However, after the tax, the area between the pre-tax price and the new higher price is no longer part of the producer surplus. Instead, it is now part of the tax revenue collected by the government. The rest of the producer surplus, which is below the new higher price, represents the net benefit received by the producers.
3. Government Revenue: The area between the pre-tax quantity and the new lower quantity (where the new higher price intersects with supply 2) represents the tax revenue collected by the government. This area is calculated by multiplying the tax amount ($1.00) by the quantity of pizzas sold after the tax.
4. Deadweight Loss: Deadweight loss represents the economic inefficiency caused by the tax. It is the triangular area between the demand curve and the new supply curve (supply 2) within the relevant price and quantity range. Deadweight loss occurs because the tax reduces the quantity traded in the market, leading to a loss of mutually beneficial transactions.
In summary, the area between supply 1 and supply 2 is not considered tax revenue. The tax revenue is only the area between the pre-tax quantity and the new lower quantity. The remaining part of the producer surplus below the new higher price represents the net benefit received by the producers.