Consumer Surplus, Producer Surplus and Taxes

Consumer surplus is the difference between what a consumer is willing to pay and what he actually pays. It basically measures consumer welfare because the higher the consumer surplus the better it is for the consumer and vice versa.

 As shown on the above graph, the consumer surplus can be found by measuring the area of the triangle above the equilibrium price and below the demand curve.

Producer surplus is the difference between how much a producer is willing to accept and what he actually gets. Similar to consumer surplus, producer surplus measures producer welfare because the higher the producer surplus the better it is for the producer.

We can find the producer surplus by finding the area of the triangle below the equilibirum price and above the supply curve.

Effect of taxes

Tax revenue = total area of rectangle made up of consumer's burden of tax and producer's burden of tax.

When the government imposes a tax of $x on the price of a good then the supply curve shifts to the left by $x for every unit of quantity demanded. Deadweight loss (DWL) is the area of the triangle lower than the original equilibrium quantity and between the two supply curves. It is a loss of economic allocative efficiency from society.