Essy Questions


A. producer surplus

Producer surplus according to Hardwick (2002) is the benefits to the producer when products are sold at a price higher than what producers are willing to sell them. In a supply curve and demand curve diagram producer surplus can be measured by determining the following area:

From the above diagram the producer surplus is the area under the supply curve and the equilibrium price P0. Therefore to determine the producer surplus this area is determined.

B. cost to sellers and the Supply curve:

according to Hardwick (2002) the supply curve is the quantity of products a producer is willing to sell at a given price, the supply curve is derived from the marginal cost curve of the producer, it is the additional cost a producer will face by producing one extra amount of a product, therefore the supply curve and the cost of producers are related given than the supply curve is derived from the marginal cost curve.

C. producer surplus when the price of a good rises:

Essy Questions

If all factors are held constant then an increase in the price of a product the producer surplus increase, when the price rises the revenue per unit of a product sold increases resulting into an increase in producer surplus

Assuming that demand curve shifts from demand curve 1 to demand curve 2 resulting into an increase in the price from P0 to P1, then producer surplus increases by the area indicated by A.

QUESTION 2. Tax and gains from trade:

When a tax is imposed on a product the price of that product increases(Hardwick, 2002), the tax will affect the producer surplus, consumer surplus, dead weight loss and demand Tax affects sales whereby when a tax is imposed consumers will demand less of that good because its price increases.

According to Hardwick (2002) two theories explain gains from trade, this include the absolute and comparative advantage theory, imposing a tax on a product will affect the price of a product and therefore reduce the demand of that product, when the demand of that product declines then gains from trade will decline.

As the price increases due to a tax the demand for that good declines according to the law of demand, therefore as demand declines then sales levels will also decline. The tax will also affect suppliers or producers revenue, when suppliers bear a portion of the tax imposed then suppliers revenue will decline, finally the tax will affect the consumer buying power, real income is the income available to the consumer that can be used to purchase products, an increase in the price of a good reduces consumers real income and therefore reduces their buying power.

Essy Questions


a. Laffer’s theory:

Laffer’s theory of tax depict the relationship between tax rates and government revenue, at zero tax rate the government will earn zero tax revenue, also that when the tax revenue is 100% then income earners will have no incentive and therefore tax revenue will also be zero, the following diagram demonstrates this theory:

From the chart as tax rate increases from 0% to 100% the revenue increases and then starts to decline until the value is zero.

b. Dead weight loss:

Dead weight loss occurs when a tax is imposed on a product, tax result into a decline in producer surplus and consumer surplus, the total decline in consumer surplus plus producer surplus is not equal to the tax revenue obtained and the difference is what is called the dead weight loss, when a tax is increased the dead weight loss also increases, the following diagram demonstrates the impact of tax on the dead weight loss,

From the diagram a tax increases the price from P0 to P1, and this results into tax revenue equal to the area A. this results into a decline in consumer and producer revenue and also results into a deadweight loss which is indicated in the above diagram.

Essy Questions

C. Difficult in predicting what will happen as tax rate change:

Tax amount paid by consumers or producers will depend on the elastic of demand and supply, low demand elasticity will mean that more tax will be paid by consumers and low supply elasticity means that the more tax will be paid by producers. Therefore if the elasticity of demand and supply is not known then it is difficult to predict the effect of a tax rate change.

McConnell (1997) also state that a larger tax burden is paid by the inelastic factor in an economy, for example a tax on a producer will also affect the employees and consumers in the short or in the long term, for this reason therefore it is difficult to predict the full impact of a tax.


Campbell McConnell (1997) Economics: principles, problems and policies, New York: McGraw hill press.

Phillip Hardwick (2002) Introduction to modern economics, New  Jersey: Prentice hall