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When a market is in equilibrium, the gains from trade are maximized, as seen below
When a price floor is imposed (by a law stipulating a minimum price for a good or resource), sellers gain a larger producer surplus from the higher price, but buyers suffer. Also, since total trade is reduced, both buyers and sellers lose some welfare (consumer surplus and producer surplus) due to the loss of trade. These losses are referred to as "deadweight loss." Even though the sellers lose some of this deadweight loss, they make up for it through the higher price. Buyers have no such compensation. In the diagram below, the price floor is indicated as PF.
When a price ceiling is imposed (by a law stipulating a maximum price for a good or resource), buyers gain a larger consumer surplus from the lower price, but sellers suffer. Also, since total trade is reduced, both buyers and sellers lose some welfare (consumer surplus and producer surplus) due to the loss of trade. These losses are referred to as "deadweight loss." Even though the buyers lose some of this deadweight loss, they make up for it through the lower price. Sellers have no such compensation. In the diagram below, the price ceiling is indicated as PC.
When a tax is imposed, the effects on overall efficiency are similar to a price floor or price ceiling. The price paid by buyers rises to PB (the higher price resembling the effect of a price floor). The price paid to sellers falls to PS (resembling the lower price of a price ceiling). However, instead of the sellers or buyers getting an increase in producer surplus or consumer surplus, the government collect a bit of the former surpluses of both consumers and producers. This collection is called "revenue" for the government. The tax will reduce total trade, just like a price floor or price ceiling, but the reduced consumer surplus and producer surplus is often called the "excess burden," instead of being called the "deadweight loss" (you can think of them as two names for the same idea).
Move your mouse over an area to see its significance.
consumer surplus after taxes
excess burden (reduced trade) from consumers
tax from consumers
excess burden (reduced trade) from producers
tax revenue from producers
producer surplus after taxes
Consumer Surplus is the gain to buyers from trade. It is the area below the demand curve (MU) and above the price. It reflects how much more buyers value the good than they must pay to get it.
Producer Surplus is the gain to sellers from trade. It is the area above the supply curve (MC) and below the price. It reflects how much more sellers get paid for the good than their cost of selling it.

Copyright 2006 by Ray Bromley. For economics information, and other information about Ray Bromley, visit www.raybromley.com. Permission to copy for educational use is granted, provided this notice is retained. All other rights reserved.
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