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c10competitive markets applications.qxd 7/15/10 4:58 PM Page 393

10.1 THE INVISIBLE HAND, EXCISE TAXES, AND SUBSIDIES 393
per year). Producer surplus is the area above the actual supply curve S and below the
price producers receive (also $8) (producer surplus areas F G H $18 million
per year). There are no tax receipts, so the net economic benefit is $54 million per
year (consumer surplus producer surplus), and there is no deadweight loss.
With the tax, consumer surplus is the area below the demand curve and above the
d
price consumers pay (P $12) (consumer surplus area A $16 million per year).
What about producer surplus? The producer surplus on a unit sold is equal to the dif-
s
ference between the net after-tax price that sellers receive (P $6) and the marginal
cost of that unit. Because it is the actual supply curve S that shows the relationship be-
tween the net after-tax price and the quantity supplied, we compute the producer sur-
plus as the area above the actual supply curve S and below the $6 net after-tax price
s
that producers receive (P ) (producer surplus area H $8 million per year). Tax re-
ceipts are the number of units sold (4 million) times the tax per unit ($6) (tax receipts
the rectangle consisting of areas B C G $24 million per year). The net eco-
nomic benefit is $48 million per year (consumer surplus producer surplus tax
receipts), so the deadweight loss is $6 million per year (net economic benefit with no
tax net economic benefit with tax $54 million $48 million).
The deadweight loss of $6 million arises because the tax reduces consumer sur-
plus by $20 million and producer surplus by $10 million (equals $30 million total),
while generating tax receipts of only $24 million ($24 million $30 million $6
million). In Figure 10.3, the deadweight loss is the sum of areas E ($4 million per year)
and F ($2 million per year), both of which were part of the net benefit with no tax.
Area E was part of consumer surplus and area F was part of producer surplus, and both
of these benefits disappeared because the tax caused consumers to reduce their purchases
and producers to reduce their output, from 6 million units to 4 million units.
The potential net economic benefit is constant and is equal to the sum of con-
sumer surplus, producer surplus, tax receipts, and deadweight loss (in this case, $54
million). The actual net economic benefit, however, decreases by an amount equal to
the deadweight loss. All this is shown in the following table:

Consumer Producer Tax Deadweight Net Economic
Surplus Surplus Receipts Loss Benefit
With No Tax $36 million $18 million 0 0 Potential: $54 million
Actual: $54 million
With Tax $16 million $8 million $24 million $6 million Potential: $54 million
Actual: $48 million

LEARNING-BY-DOING EXERCISE 10.1
S
D
E
Impact of an Excise Tax
d
In this exercise we determine the equilib- where Q is the quantity demanded when the price
d
s
rium prices and quantities in Figure 10.3, using algebra. consumers pay is P , and Q is the quantity supplied
s
The demand and supply curves in Figure 10.3 are as follows: when the price producers receive is P . The last line of
the supply equation indicates that nothing will be sup-
d
Q 10 0.5P d plied if the price producers receive is less than $2 per
unit. Thus, for prices between zero and $2, the supply
s
s
2 P , when P 2
s curve lies on the vertical axis.
Q e s
0, when P 6 2