Tax and Consumer Surplus

Introduction

The news and theory under analysis is Tax and consumer surplus, extracted from the news “State's year-to-date revenue surplus $63 million” published in Daily Mail on 1 Mar 2012.

In economics, consumer's surplus refers to the difference between what a buyer actually pays for a product and the maximum that he would have been willing to pay. If one would have been willing to spend $40 on a shirt, but find it on sale for $10, one would realize a consumer surplus of $30 on the purchase. Consumers' surplus is used to refer to the aggregate difference between what consumers would be willing to pay for a given good or service and what they actually do pay (the market price).?

Discussion and Analysis

Within any given market, price competition tends to minimize producer surplus and maximize consumer surplus. (The exact nominal value of producer and consumer surplus in any given market depends on the cost and demand structures of that market.) According to economic theory, producers are forced by price competition to sell their products at marginal cost (roughly, the cost to them of producing the last item to be sold). Every consumer—even those who value a product very highly and would be willing to pay much more for it—will be able to buy that product at its marginal cost and, thus, realize substantial consumer surplus. Producers in a competitive market also realize some producer surplus, however. The amount realized will increase to the extent that the producer's average production costs are below the market price.

Price discrimination is the sale of identical goods to different buyers at different prices. Price discrimination on the part of sellers can shift social surplus from consumers to producers. A seller who can price discriminate perfectly will charge each of his buyers exactly the highest price that that buyer is willing to pay. Such a seller will sell the same amount of goods as would be sold in a competitive market, but no buyer will realize any consumer surplus, and the seller will realize the maximum possible producer surplus. Perfect price discrimination, in other words, gives the entire social surplus to the producers.

Perfect price discrimination is difficult to achieve, since it involves knowing each individual customer's willingness to pay. It is also difficult to maintain: It is undercut by price competition and, even where there is little competition, by arbitrage among customers. But even imperfect price discrimination transfers some social surplus from consumers to producers. This is why retailers commonly use various tactics (e.g., airline “Saturday overnight stay” rates that create differential prices for business and nonbusiness flyers) to charge their different customers prices closer to their maximum willingness to pay.

A perfectly price-discriminating monopolist would, in theory, be able to sell the same number of goods as would be sold in a price-competitive market, while keeping all the social surplus on the producer's side rather than on the consumer's side. In practice, however, because price discrimination is difficult to achieve and maintain, monopolists have to set ...