How does a higher tax change consumer surplus, producer surplus, and the excess burden of the tax? The higher tax, _
A. increases consumer surplus and producer surplus and decreases the excess burden of the tax
B. increases producer surplus and decreases consumer surplus and the excess burden of the tax
C. decreases consumer surplus and increases producer surplus and the excess burden of the tax
D. decreases consumer surplus and producer surplus and increases the excess burden of the tax
The correct answer and explanation is:
The correct answer is D: decreases consumer surplus and producer surplus and increases the excess burden of the tax.
Explanation:
A higher tax leads to several economic consequences for both consumers and producers. Let’s break it down:
- Consumer Surplus: Consumer surplus is the difference between what consumers are willing to pay for a good and what they actually pay. When a tax is levied, the price consumers pay for the good increases. This price increase reduces the amount of consumer surplus because consumers now face a higher price for the same good or service. As a result, the area representing consumer surplus on a supply and demand graph shrinks.
- Producer Surplus: Producer surplus is the difference between the price producers receive for a good and the minimum amount they are willing to accept. While producers may be able to pass some of the tax onto consumers by increasing the price, they may still experience a reduction in producer surplus. This happens because the tax raises the cost of doing business, and the overall price received by producers (after tax) decreases. As a result, producers may sell fewer units at a lower price, reducing their surplus.
- Excess Burden of the Tax: The excess burden (also called the deadweight loss) refers to the loss of economic efficiency when a tax distorts the market equilibrium. A higher tax increases the excess burden because it reduces the quantity of goods exchanged. When the tax is imposed, the market price rises for consumers, and the effective price received by producers falls, leading to a decrease in the overall volume of trade. This reduction in trade represents an economic loss that is not captured as tax revenue but instead as deadweight loss.
In summary, higher taxes decrease both consumer and producer surplus because they increase prices for consumers and reduce prices for producers. At the same time, they increase the excess burden or deadweight loss due to the reduction in market transactions.