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Question

What happens to consumer and producer surplus when the sale of a good is taxed? How does the change in consumer and producer surplus compare to tax revenue? Explain.

Answer 1

Consumer surplus can be considered as the general feeling of welfare one gets when entering into transaction. This is a welfare concept and fair exchange is the reason why this happens. Said so this will be visible only in economies where fair exchange is the norm in transaction. Since I said it is a welfare phenomenon, then indirect taxes are not encouraged in welfare economies, very rarely indirect taxes are charged on goods so generally you cannot expect much change in consumer surplus. Producer surplus is the excess profit the vendor generates. This also should not produce any change per se. Economies that are not welfare oriented consumer surplus and producer surplus doesn't make sense since running the economy there is a whole different ball game something like the centrally planned ones where some necessities in welfare economies will be considered there as luxury and so on and so forth.