In this example we consider the price, production and welfare effects of a consumption tax when the taxed commodity is initially imported in the country. We depict the initial equilibrium in the adjoining diagram. The free trade price is given by P FT . When a consumption tax is imposed the effective demand curve shifts to D' . The letters refer to the area in the previous graph.
Red letters indicate losses while black letters indicate gains.
National Welfare - e Consumers suffer a loss in surplus because the price they pay rises by the amount of the consumption tax. Notice that the consumer surplus change is read off of the original demand curve, not the effective demand curve. Note that even though imports fall, this decrease has no positive effect on producers in this situation. Finally, the government receives tax revenue from the consumption tax. The revenue is calculated as the tax, t, times the quantity purchased, D 2 .