Question

What is the welfare effect in terms of areas on the supply and demand graph; that show consumer surplus, government revenue AND loss to producers Graphically, what is the welfare effect for the U.S.?

Answer 1

Let's familiarize with the basic terminology:

Consumer Surplus is the difference between the price that consumers pay and the price that they are willing to pay. On a supply and demand curve, it is the area between the equilibrium price and the demand curve.

Producer surplus is the difference between how much a person would be willing to accept for given quantity of a good versus how much they can receive by selling the good at the market price. The difference or surplus amount is the benefit the producer receives for selling the good in the market.

Government revenue is the money received by a government from taxes and non-tax sources to enable it to undertake government expenditures.

Let's assume US government imposes sales tax, note that whether the tax is levied on the consumer or producer, the final result is the same, proving the legal incidence of the tax is irrelevant. A tax drives a wedge between the price consumers pay and the revenue producers receive, equal to the size of the tax levied.

As illustrated below, to find the new equilibrium, one simply needs to find a $3 wedge between the curves.

As depicted above, consumer surplus has reduced, also producer started facing losses, US Government is getting a revenue of $3 as tax revenue from the sale of gallons of oil. The rectangle indicates U.S. Government welfare.