Page 549 - Krugmans Economics for AP Text Book_Neat

figure 50.11

A Tax Reduces Consumer and Price
Producer Surplus
Fall in consumer
Before the tax, the equilibrium price and quantity surplus due to tax S
are P E and Q E , respectively. After an excise tax of T
per unit is imposed, the price to consumers rises
to P C and consumer surplus falls by the sum of the P C
dark blue rectangle, labeled A, and the light blue Section 9 Behind the Demand Curve: Consumer Choice
triangle, labeled B. The tax also causes the price A B
Excise
to producers to fall to P P ; producer surplus falls by tax = T P E E
the sum of the dark red rectangle, labeled C, and C F
the light red triangle, labeled F. The government
receives revenue from the tax, Q T × T, which is P P
given by the sum of the areas A and C. Areas B
and F represent the losses to consumer and pro-
Fall in producer
ducer surplus that are not collected by the govern- surplus due to tax D
ment as revenue; they are the deadweight loss to
society of the tax.
Q T Q E Quantity

Meanwhile, the fall in the price received by producers leads to a fall in producer sur-
plus. This, too, is equal to the sum of the areas of a rectangle and a triangle. The loss in
producer surplus is the sum of the areas of the dark red rectangle labeled C and the
light red triangle labeled F in Figure 50.11.
Of course, although consumers and producers are hurt by the tax, the government
gains revenue. The revenue the government collects is equal to the tax per unit sold, T,
multiplied by the quantity sold, Q T . This revenue is equal to the area of a rectangle Q T
wide and T high. And we already have that rectangle in the figure: it is the sum of rec-
tangles A and C. So the government gains part of what consumers and producers lose
from an excise tax.
But a portion of the loss to producers and consumers from the tax is not offset by a
gain to the government—specifically, the two triangles B and F. The deadweight loss
caused by the tax is equal to the combined area of these two triangles. It represents the
total surplus lost to society because of the tax—that is, the amount of surplus that would
have been generated by transactions that now do not take place because of the tax.
Figure 50.12 on the next page is a version of Figure 50.11 that leaves out rectangles A
(the surplus shifted from consumers to the government) and C (the surplus shifted
from producers to the government) and shows only the deadweight loss, drawn here as
a triangle shaded yellow. The base of that triangle is equal to the tax wedge, T; the
height of the triangle is equal to the reduction in the quantity transacted due to the
tax, Q E − Q T . Clearly, the larger the tax wedge and the larger the reduction in the quan-
tity transacted, the greater the inefficiency from the tax. But also note an important,
contrasting point: if the excise tax somehow didn’t reduce the quantity bought and sold
in this market—if Q T remained equal to Q E after the tax was levied—the yellow triangle
would disappear and the deadweight loss from the tax would be zero. So if a tax does
not discourage transactions, it causes no deadweight loss. In this case, the tax simply
shifts surplus straight from consumers and producers to the government.
Using a triangle to measure deadweight loss is a technique used in many economic ap-
plications. For example, triangles are used to measure the deadweight loss produced by
types of taxes other than excise taxes. They are also used to measure the deadweight loss
produced by monopoly, another kind of market distortion. And deadweight-loss trian-
gles are often used to evaluate the benefits and costs of public policies besides taxation—
such as whether to impose stricter safety standards on a product.

module 50 Efficiency and Deadweight Loss 507