What this lesson teaches
I can show how each intervention changes price, quantity, spending, revenue, consumer surplus and producer surplus.
Syllabus 9570, 2.1.3(b). Government Intervention in Markets: Government intervention in markets can affect the equilibrium price and quantity, consumer expenditure and producer revenue, consumer surplus and producer surplus
Make a guess
Buyers pay $10 a unit, the tax is $3 a unit, and 100 units are sold. How much do sellers keep?
- $1,000, because buyers paid $10 for each unit.
- $700, because they keep $7 on each unit.
- $1,300, because sellers add the tax to the price.
Show the answer
$700, because they keep $7 on each unit.
Sellers keep the price minus the tax: $10 - $3 = $7. Times 100 units gives $700.
Use the right price: buyers pay one price, sellers receive another, and the government covers the gap.
With a tax or a subsidy, buyers and sellers face different prices. Getting the calculation right means using the correct one.
Consumer expenditure is the price buyers pay times the quantity bought.
Producer revenue is what sellers actually get per unit times the quantity sold. With a tax, that is the price minus the tax. With a subsidy, it is the price plus the subsidy.
Government revenue from a tax, or spending on a subsidy, is the amount per unit times the quantity sold. None of these figures is profit, since costs are not included.
- Consumer spending
- Price paid x quantity.
- Producer revenue
- Price received x quantity.
- Not profit
- Costs are still missing.
| Policy | Buyers pay | Sellers get | Units | Government |
|---|---|---|---|---|
| None | $6 | $6 | 80 | $0 |
| $2 tax | $7 | $5 | 60 | +$120 |
| $2 subsidy | $5 | $7 | 100 | -$200 |
Worked example: Accounting for a subsidised market
Buyers pay $8 a unit, sellers get a $2 subsidy on each unit, and 75 units are sold.
- Consumer spending: $8 x 75 = $600.
- Government spending: $2 x 75 = $150.
- Producer revenue: ($8 + $2) x 75 = $750, which equals $600 + $150.
- If total costs are $680, profit is $750 - $680 = $70. Without cost figures, we cannot find profit.
Watch out for this
Consumer spending always equals producer revenue.
Only without taxes or subsidies. A tax takes part of what buyers pay; a subsidy adds to what sellers receive.
Check your understanding
Before a $4 tax the market price was $15. After it, the price is $18. How much of the tax on each unit falls on sellers?
- $1, because they now keep $14 instead of $15.
- $4, because sellers hand the whole tax to the government.
- $3, the rise in the price that buyers pay.
Show the answer
$1, because they now keep $14 instead of $15.
Right. Sellers keep $18 - $4 = $14, which is $1 less than before. Buyers bear the other $3.