Consumer and Producer surplus / Indirect taxes amd subsidies

What is consumer surplus?

The difference between the price the consumer is willing to pay and the price they actually pay, set by the price mechanism.

What is producer surplus?

The difference between the price the supplier is willing to produce at and the price they actually produce at, set by the price mechanism.

How does a decrease in demand affect consumer and producer surplus?

Consumer and producer surplus will fall, as both price and output decrease.

How does a decrease in supply affect consumer and producer surplus?

Consumer and producer surplus will fall.

What is an indirect tax? What are the two types?

A tax on expenditure of goods and services, paid to the government by producers but passed indirectly onto consumers.

Ad valorem: Charged as a percentage of price of the good (E.g. VAT)

Specific tax: Charged at a specific rate per unit, regardless of price (E.g. Alcohol duties)

Impact of indirect taxes on consumers?

Consumers see higher prices and suffer from increased tax burden.

Impact of indirect taxes on producers?

Producers see a rise in costs and a fall in output, suffering from increased tax burden.

Impact of indirect taxes on government?

Government gains tax revenue. (Consumer burden + producer burden)

Why does supply curve shift and tilt for ad valorem tax?

Because tax is a percentage of the value of good. When price is small, the tax will only be a small amount, but when price is high, the tax will be a large amount.

How does PED and PES affect incidence of tax on consumers and producers?

If PED is relatively elastic, or PES is relatively inelastic, the supplier will pay most of the tax. If PED is relatively inelastic, or PES is relatively elastic, the consumer will pay most of the tax.

If PED is more inelastic, government receives more tax revenue, because quantity demanded falls less and more goods are purchased at a higher price.

What is a subsidy?

A payment from the government directly to firms in order to encourage production and consumption of a good/service.

Impact of subsidy on consumers? Good and bad?

Lower prices and encourages consumption of a good/service deemed beneficial to society (merit good).

However, lower prices may not be passed on consumers.

Impact of subsidy on producers? Good and bad?

Fall in cost of production and increased output. Also, protects domestic industries, keeping them competitive.

However, firms may become reliant on subsidy in the long run, becoming inefficient.

Impact of subsidy on government? Good and bad?

Increased societal welfare from increased consumption.

However, opportunity costs incurred, and subsidy may not be successful.

What is the consumer subsidy and the producer subsidy?

Consumer subsidy is the area shown by the fall in price. The rest is producer subsidy.