Question

7. How does a tax impact consumer and producer surplus? 8. Describe how deadweight loss changes when demand is elastic and inelastic.

Answer 1

7.

• When taxes are imposed on consumer's and producer's, both the consumer surplus and producer surplus is lost.
• Loss in consumer surplus and the producer surplus is termed as deadweight loss or loss in total surplus is called as deadweight loss.
• When the tax is levied on consumer's, their demand for goods and services falls as taxes Increases their prices and hence increases their incentive to consume less.
• Similarly when an excise tax is levied on producer's, they face high marginal costs of production and thus they are forced to produce and supply less.
• Both of them, that is consumer's and producer's incur more losses than gains from trade. Hence we can say that the total surplus is lost due to the taxes imposed.

8.

• The deadweight loss is impacted by the changes in elasticity of demand.
• When the demand for any good or a service is elastic the deadweight loss of a tax increases. This is because people with elastic demand will defer from paying higher prices when the price's rise due to taxes. But when the taxes fall and the prices fall, their demand rises and their willingness to pay increases.
• When the demand for any good or a service is inelastic, the deadweight loss of a tax will not be much strong as in the case of an elastic demand. This is because people will be indifferent to the changes in the prices and will consume even if the prices rise due to taxes.