Posted by Anjali Kaur on May 20, 2020

What is the welfare effect in terms of areas on the supply and demand graph on the US economy?

I have been asked this question from one of my ex-student on whats-app.

Let’s familiarize with some basic terminology before coming to any conclusion:

Consumer Surplus is the difference between the price that consumers pay and the price that they are willing to pay. In market equilibrium, 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 a given quantity of a good versus how much they can receive by selling the goods at the market price. The difference or surplus amount is the benefit the producer receives for selling the good in the market. As shown below:

Government revenue is the money received by a government from tax and non-tax sources to enable them 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, which is 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, the 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.

Hope it helps, if you have any economics-related questions for me then email at contact@LearnWithAnjali.com

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