Question

With aids of graph, define consumer & producer surplus. Then show how the deadweight loss affects efficiency. 1- Consumer surplus is 2- Producer surplus is 3- Govemment revenue 4- Deadweight loss is 5- Total surplus is

Answer 1

The Consumer suplus is the amount extracted by the consumers which is calculated by willingness to pay minus the actual price of the commodity. It is shown by A in the above diagram.

The producer surplus is the amount extracted by the producers which is calculated by the actual price of the commodity minus the willingness to sell. It is shown by B in the above diagram.

Now, government imposes a tax to reap the goverment revenue out of consumers and producers. So, the diagram becomes,

Here, government earns a revenue by taxing it's  product and it is shown by C + D in the diagram.

Here, the producer surplus is B and the consumer surplus is A.

The deadweightloss is shown by F + G in the diagram.

Here, is the equilibrium Price and Q' is the equilibrium quantity where is the efficient quantity without goverment taxation.

The Total Surplus is given by ,

T.S = Consumer Surplus + Producer Surplus

Here, T.S is represented by A + B region in the above diagram.

The welfare is calculated by,

Welfare = Counsumer Surplus + Producer Surplus + Government Revenue

Without Government intervention( without taxation),

Welfare = A + C + F + B+ D + G, where A + C + F is the Consumer surplus without taxation and B + D + G is the producer surplus without taxation. And here is no government revenue.

But with government intervention, ( with taxation)

Welfare = A + B + C + D , where A is consumer surplus, B is producer surplus and C + D is government revenue

So, welfare reduces since a deadweightloss of F + G is involved. And hence, dead weightloss reduces the efficiency and it makes the equilibrium quantity to fall from to Q' .