Question

Questions 3 & 4 are more important.

1. Explain consumer and producer surplus and provide an example of each.
2. What happens to the consumer surplus and producer surplus when price increases or decreases?
3. Explain the relationship between the tax size and deadweight loss.
4. When tax causes deadweight loss then why it is imposed in the first place? Who gains in this situation? Also if tax has to be imposed how to determine what size of tax will generate optimum tax revenue for the government?

Answer 1

3

Since the consumer surplus is the area below the demand curve and above the price. It will be positive when the price the consumer is willing to pay is more than the market price.

Producer surplus is the area below the market price and above the supply curve.

When the price increases the consumer surplus decreases while the producer surplus increases\

.4

There is positive relationship between tax size and deadweight loss. This is because when tax size increase, there is more distortions therefore the DWL increases.

Although the tax leads DWL, even then tax is imposed because it generate tax revenue and it help to reduce the negative externality.

The government gains because it receives tax revenue and society also benefits because negative externality reduces.

A tax rate will generate optimum tax revenue for the government if with the increase in the tax rate the tax revenue increases. When with the increase in the tax rate the tax revenue decreases, it is not a optimum tax.