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Deadweight Loss

Deadweight loss refers to economic inefficiency that occurs when the market equilibrium is not Pareto optimal. This means that either consumers who value a good or service more than its cost are not buying it, or consumers who value it less than its cost are buying it. Causes of deadweight loss include monopoly pricing, externalities, and taxes/subsidies that create price floors or ceilings. Deadweight loss is also known as excess burden and represents lost economic value.

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1K views1 page

Deadweight Loss

Deadweight loss refers to economic inefficiency that occurs when the market equilibrium is not Pareto optimal. This means that either consumers who value a good or service more than its cost are not buying it, or consumers who value it less than its cost are buying it. Causes of deadweight loss include monopoly pricing, externalities, and taxes/subsidies that create price floors or ceilings. Deadweight loss is also known as excess burden and represents lost economic value.

Uploaded by

Manoj K
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© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Deadweight loss

Deadweight loss created by a binding price ceiling. Producer surplus is necessarily decreased, while consumer
surplus may or may not increase; however the decrease in producer surplus must be greater than the increase
(if any) in consumer surplus.

In economics, a deadweight loss (also known as excess burden or allocative inefficiency) is a loss of economic
efficiency that can occur when equilibrium for a good or service is not Pareto optimal. In other words, either
people who would have more marginal benefit than marginal cost are not buying the product, or people who
would have more marginal cost than marginal benefit are buying the product.

Causes of deadweight loss can include monopoly pricing (see artificial scarcity), externalities, taxes or subsidies
(Case and Fair, 1999: 442), and binding price ceilings or floors. The term deadweight loss may also be referred to
as the "excess burden" of monopoly or taxation.

Examples
For example, consider a market for nails where the cost of
each nail is 10 cents and the demand will decrease linearly
from a high demand for free nails to zero demand for nails
at $1.10. In a perfectly competitive market, producers
would have to charge a price of 10 cents and every
customer whose marginal benefit exceeds 10 cents would
have a nail. However if there is one producer who has a
monopoly on the product, then they will charge whatever
price will yield the greatest profit. For this market, the
producer would charge 60 cents and thus exclude every
customer who had less than 60 cents of marginal benefit.
The deadweight loss is then the economic benefit forgone by these customers due to the monopoly pricing.

Conversely, deadweight loss can also come from consumers buying a product even if it costs more than it
benefits them. To describe this, let's use the same nail market, but instead it will be perfectly competitive, with
the government giving a 3 cent subsidy to every nail produced. This 3 cent subsidy will push the market price of
each nail down to 7 cents. Some consumers then buy nails even though the benefit to them is less than the real
cost of 10 cents. This unneeded expense then creates the deadweight loss: resources are not being used
efficiently.

If the price of a glass of beer is $3.00 and the price of a glass of wine is $3.00, a consumer might prefer to drink
beer. If the government decides to levy a beer tax of $3.00 per glass, the consumer might prefer to drink wine.
The excess burden of taxation is the loss of utility to the consumer for drinking wine instead of beer, since
everything else remains unchanged. Most notably the tax revenue from this consumer is zero.

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