Principles of Economics, 7th Edition

Published by South-Western College
ISBN 10: 128516587X
ISBN 13: 978-1-28516-587-5

Chapter 8 - Part III - Application: The Costs of Taxation - Problems and Applications - Page 170: 8

Answer

Consumer surplus and producer surplus both increase. The government loses tax revenue (due to the subsidy). Total surplus decreases, and there is a deadweight loss.

Work Step by Step

In the graph, the original equilibrium quantity and equilibrium price (respectively) are $Q_{0}$ and $P_{0}$. The original consumer surplus is the sum of areas $A+B$, and the original producer surplus is the sum of areas $C+D$. There is no tax revenue, and total surplus is the sum of areas $A+B+C+D$. With the subsidy, the equilibrium quantity and equilibrium price (respectively) are $Q_{1}$ and $P_{C}$. The new consumer surplus is the sum of areas $A+B+C+F+G$, and the new producer surplus is the sum of areas $B+C+D+E$. There is now a loss of tax revenue of the sum of the areas $B+C+E+F+G+H$, and total surplus is now the sum of areas $A+B+C+D-H$. Since total surplus was $A+B+C+D$, and now total surplus is $A+B+C+D-H$, there is a deadweight loss of $H$.
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