Indirect taxes and deadweight loss

Question 1

After indirect taxes, what happens to CS and why?

Answer 1

• decreases by two units
• Consumers lose out as they now have to pay. higher price

Question 2

After indirect taxes, what happens to PS and why?

Answer 2

• decreases by two units
• Producers lose out as they now receive a lower price due to them charging lower prices due to price elastic demand thus, profits decrease too

Question 3

After indirect taxes, what happens to Gov. Revenue and why?

Answer 3

• increases by two units
• because there is gov. revenue, the lost areas (a and d) are recovered via gov. revenue hence, they are not considered to be a deadweight loss

Question 4

After indirect taxes, what happens to TS and why?

Answer 4

• decreases by two units
• This is due to a DWL occurring as society loses out due to the underproduction and underconsumption of goods and services (For demerit goods, indirect taxes are imposed to reduce production and consumption thus, underprovision is not a problem in that case)

Question 5

Thus, what evaluation do governments have to make when considering DWLs

Answer 5

• Govs. have to bear in mind whether the deadweight loss is worth the increase in tax revenue: If the gov. revenue is going to be used for major beneficial areas in the economy and that outweighs the costs incurred by the DWL, this can be a reason to proceed with the indirect tax or not.