Question

Draw the supply and demand curves for cookies. If the government imposes a tax on cookies, show what happens to the price paid by buyers, the price received by sellers, and the quantity sold. In your diagram, show the deadweight loss from the tax. Explain the meaning of the deadweight loss

Answer 1

Answer : In the following picture's diagram the supply curve and demamd curve are shown. After imposing tax on cookies the market supply decrease which shift the market supply curve to leftward. In the following picture's diagram after tax impose the supply curve is Supply + Tax. As a result of this tax the price of cookies rises and becomes P1 from P. Hence after tax impose buyers pays higher price but sellers receives only P2. This means that due to tax the sellers receives less price although buyers pays high price. Due to high price after tax impose the quantity demanded decreases. Hence quantity sold decreases from Q to Q1. Due to tax impose the deadweight loss occur which is shown by the shaded area in the following picture's diagram.

Deadweight loss occur when the market is not in equilibrium. Deadweight loss is the loss of economic efficiency. The loss of inefficiency occur when the distribution of resources is inefficient. The market inefficiency create the cost to society. This cost is the loss of welfare which is known as deadweight loss.