Discuss the impact on government, consumers, and producers of a specific tax in the market for

flour.
[15 marks]

A specific tax is a tax on a good. The amount of the tax is an absolute amount on each unit sold. For
example, a $2 tax on flour would be a specific tax. Since producers pay the tax to the government, taxes
erode the profitability of selling a good at all price levels and so at all prices, the quantity of firms supplying
the good diminishes. This leads to a decrease in the quantity supplied at all prices; supply decreases
(supply is the quantity of a good that firms are willing and able to supply at all prices during a particular
moment in time). This is represented on a supply and demand diagram by an upward shift of the supply
curve by the amount of the tax.

In our specific example the tax on flour makes it harder for firms to make a profit by selling flour. Thus, at
all prices the number of firms supplying flour will decrease. This causes the quantity supplied to also
decrease at all price levels. Since the tax was a $2 tax the supply curve below moves upwards from S to
S​tax​; exactly $2 upward at all points.

As shown on the diagram, the tax causes the equilibrium quantity to decrease from Q​e​ to Q​tax​. The tax also
increases the price but not by the full $2; if it did the price would be P​1​ and not P​tax​. This is because
producers can’t let consumers bear all of the tax burden. If they did, the quantity demanded would
decrease even more - as per the law of demand (quantity demanded decreases as price increases) and
thus producers would make even less money.

The tax clearly has a negative impact on consumers as they now buy less at a higher price. This decrease
in market activity (in addition to the tax) causes consumer surplus (benefit that consumers get when the
price they pay for a good is less than what they were willing to spend) to shrink. Whereas before the tax
consumer surplus was made up of areas a+b+c on the diagram, it is now only made up of area a. Area b is
now the money that consumers give to the government as a tax, while area c is completely lost because
once again, that extra amount (Q​e​ - Q​tax​) is no longer bought by producers.

The tax also affects producers negatively. Although the price increased, revenue for producers actually
decreased because they have to pay part of the tax. Whereas before the tax producer revenue was P​e​ x
Q​e​, (d+e+f+g+h) it is now only P​2​ x Q​tax​ (f+g). As a consequence of the decrease in market activity,
producer surplus (benefit from selling a good above the price willing to sell) also decreased. Before the tax
it was area d+e+f. However, after the tax it is only f as area d is the revenue the government gets from
producers while e is lost market activity.
The government is the only one that benefits from the tax as they make money (represented by area b+d).
Thus although producers and consumers lose surplus, some of it isn’t really lost as it goes to the
government which can in turn use that money to improve society. However, this benefit does not outweigh
the loss because as mentioned earlier, areas c+e are completely lost due to the decrease in market activity;
they are deadweight.

Seeing as how flour causes no extra harm to society and it is most likely to be used by poor income
households, it is clearly a bad idea to tax flour. Finally, since the demand for flour isn’t very inelastic the tax
won’t generate that much revenue for the government.