Question

In which of the following situations can you say, without further information, that consumer surplus decreases relative to the market equilibrium level? [LO 5.6] a. Your state passes a law that pushes the interest rate (i.e., the price) for payday loans below the equilibrium rate. b. The federal government enforces a law that raises the price of dairy goods above the equilibrium. c. Your city passes a local property tax, under which buyers of new houses have to pay an additional 5 percent on top of the purchase price. d. The government lowers the effective price of food purchases through a food- stamp program.

Short answer

Consumer surplus decreases with price floors or added taxes above equilibrium.

Step-by-step solution

Understanding Consumer Surplus

Consumer surplus is the difference between what consumers are willing to pay for a good and what they actually pay. It represents the benefit consumers get by paying a lower price than the maximum they are willing to pay.

Effect of Price Ceiling

A price ceiling, such as an interest rate cap on payday loans, typically lowers the price below equilibrium. This increases consumer surplus, as consumers pay less than their maximum willingness.

Effect of Price Floor

A price floor, such as raising the price of dairy goods above the equilibrium, decreases consumer surplus. Consumers have to pay more than they would at the equilibrium price, receiving less benefit.

Impact of Additional Taxes

An additional property tax on new homes increases the purchase price for buyers. This higher price reduces consumer surplus, as buyers pay more than they would in a tax-free market.

Subsidy Effects

When the government lowers the effective price through subsidies, such as a food-stamp program, consumer surplus increases, as consumers pay less than the equilibrium price.

Conclusion

Situations that decrease consumer surplus are primarily those where the consumer pays more than the market equilibrium price, such as price floors and added taxes.

Key concepts

Price Ceiling

Imagine a country where the government decides that certain goods or services are becoming too expensive for consumers. To help, they implement something known as a "price ceiling." This is a legal maximum price that can be charged for a product, set below the normal market equilibrium price. When a price ceiling is set, it means that consumers will not have to pay more than this maximum price.
For example, if there's an interest rate cap on payday loans, it forces the price below what the equilibrium would naturally be. In theory, this should increase the consumer surplus because consumers are paying less than they would be willing to for a certain service.
However, there are downsides — while consumers pay less, they may also face shortages. That's because producers might produce less of the good or service due to decreased profitability. They'll want to charge more, but the ceiling stops them from doing so.

Price Floor

A price floor is essentially the opposite of a price ceiling. It's a legal minimum price that must be paid for a good or service, set above the market equilibrium price. The intention here might be to ensure that producers can earn at least a minimum amount.
Consider the case of dairy goods, where the government might impose a price floor to support farmers. As a result, this leads to a higher price for these goods than consumers would normally pay in an unconstrained market.
This increase in price reduces consumer surplus because consumers end up paying more than they want to. The price they face is higher than the market equilibrium, meaning they do not enjoy the same savings or benefits they would without a floor. In some instances, this can also lead to surpluses, where too much of a product is being produced and not enough is sold.

Subsidies

Subsidies are like a helping hand from the government to make certain goods or services more affordable for consumers, or to support producers. They effectively lower the price of the product below the market equilibrium price.
Consider food stamps, which are a form of subsidies for low-income families. When families use food stamps, their effective spending on food is lower than the selling price of the goods. This increase in consumer surplus occurs because these consumers end up paying less out of pocket while still enjoying the same, or more, goods.
Subsidies encourage more consumption by making goods cheaper and more accessible to a wider audience. In turn, it can lead to an increase in demand and can stimulate economic activity, although it can also place a financial burden on the government's budget.

Taxes

Taxes imposed on goods or services raise the overall cost for consumers. Whenever a new tax is introduced, such as a 5% property tax on new homes, it increases the purchase price for buyers.
This higher price means a decrease in consumer surplus. Buyers have less surplus because their total cost is now above the equilibrium price, leading them to pay more than they would like or are willing based on demand alone.
Taxes can discourage consumption by making goods more expensive. The government usually imposes taxes to raise revenue, fund public projects, or discourage the consumption of certain products. However, it's essential to understand that higher taxes often result in reduced consumer satisfaction and lower surplus, as they must pay a higher market price.