Microeconomics: Theory and Applications with Calculus, 4e

9.5 Policies That Create a Wedge Between Supply and Demand Curves

Never try to kill a government program—you’ll only make it mad.

The most common government policies that create a wedge between supply and demand curves are sales taxes (or subsidies) and price controls. Because these policies create a gap between marginal cost and price, either too little or too much is produced. For example, a tax causes price to exceed marginal cost—that is, consumers value the good more than it costs to produce it—with the result that consumer surplus, producer surplus, and welfare fall (although tax revenue rises).

Welfare Effects of a Sales Tax

A new sales tax causes the price that consumers pay to rise (Chapter 2), resulting in a loss of consumer surplus, ...