Question

What is efficiency, and why is it so important? 2. What happens to consumer and producer surplus when the sale of a good is taxed? How does the change in consumer and producer surplus compare to the tax revenue?

Answer 1

The efficiency can be defined as the a situation in which the resources are allocated in a best possible way and wastage of resources has been reduced to its minimum level. This is important because efficiency increases the total surplus and inefficiency decrease total surplus.

Consumer surplus is the difference between willingness to pay and price of the product.

Producer surplus is the difference between price of the product and minimum willingness to receive.

When a tax is imposed on the product, this increases the price which a consumer pay for the product and the price which a producer receive decrease.

With the imposition of the tax , the consumer surplus as well as the producer surplus decrease. Hence the total surplus decrease because total surplus is the sum of the producer and consumer surplus.

Since the tax creates tax revenue for the government, hence the government tax revenue increases.