Deadweight Loss
Deadweight loss refers to the inefficiency that occurs when the quantity of a good or service traded in a market is below the equilibrium level. This results in a loss of potential economic welfare that could have been generated if the market was operating at its equilibrium. Deadweight loss is often associated with market distortions such as taxes, subsidies, or price controls.
3 Key excerpts on "Deadweight Loss"
eBook - ePub- E.J. Mishan, Euston Quah(Authors)
- 2020(Publication Date)
- Routledge(Publisher)
...Appendix 9 Deadweight Loss or love’s labour lost 1 When public investment is to be financed not by borrowing, but by taxation, wholly or partly – whether by excise taxes, income taxes or property taxes – an alleged consequence is the generation of a marginal Pareto loss, one that is referred to as a ‘marginal excess tax burden’ or ‘Deadweight Loss’. This alleged burden does not address itself to the amounts transferred by the taxes – the gain in spending power of the government being exactly equal (if we ignore collecting costs) to the loss of spending power of the taxpayers, but to what is sometimes called the ‘distorting’ effects of taxes, tariffs, subsidies, etc. As this term ‘distorting’ effects is used somewhat licentiously, it makes for clearer thinking to focus directly on the relevant issue: will the taxation in question move the economy as a whole closer to, or further from, an overall optimal position? And if we can determine which way, can we also measure the change in total welfare? It should be obvious that answers to these questions are related to the analysis used in establishing the Second-Best Theorem, as discussed in Appendix 3. 2 Prior to the 1950s, economic textbooks occasionally illustrated the marginal excess tax burden of an excise tax t by a wedge, equal to height t, placed between the demand and supply curve of Figure A9.1. Originally, the equilibrium price was p 1 and the equilibrium quantity x 1. Following an excise tax equal to t, the equilibrium price rises to p 2, and the equilibrium quantity falls to x 2. Figure A9.1 The amount transferred from consumers and producers together is then equal to t × O x 2 – with producers paying the amount equal to (O x 2 × p 1 p 0) and consumers paying the amount (O x 2 × p 1 p 2)...
eBook - ePubMicroeconomics
A Global Text
- Judy Whitehead(Author)
- 2014(Publication Date)
- Routledge(Publisher)
...These include the development of an informal market (black market) and the Deadweight Loss. In addition, there are several other undesirable effects particularly related to rent controls. Development of the informal market (blackmarket) The excess of demand over supply at the ceiling price leads to intrusion into the market by brokers who are able to obtain the good now in relatively short supply (with respect to demand) and who seek to re-sell them at a higher price in the informal market. From the demand curve, it can be seen that there are persons who are willing to pay a price higher than the controlled price, P C (persons are willing to pay up to the demand curve). These persons are often targeted by the re-sellers or ‘blackmarketeers’ who are able to acquire the product at the low controlled price and can re-sell at the higher prices some consumers are willing to pay for this limited quantity rather than go without. These resellers are able to capture much of the consumer surplus above P C (the areas d and a) and defeat the purpose of the price ceiling. Generation of a Deadweight Loss For this purpose, a Deadweight Loss may be defined as a loss to one group in society that is not gained by another group. With the implementation of the price ceiling, trading in the market stops at quantity Q 1. That is the total amount suppliers are willing to supply at that low price. It does not matter that consumers are willing to purchase the higher quantity Q 2 as there is no supply in this area. Consequently, the market activity is curtailed at Q 1 and, as a result of this, the attempt to put into effect the transfer of producer surplus to the consumer results in two areas of welfare loss, as follows: The producer loses areas c and d but the consumer gains only d. Thus area c may be considered an area of producer surplus lost to the producer but not gained by the consumer. The consumer, who had areas a and b, now gains area d but loses area b...
eBook - ePub- Bonnie Nguyen, Andrew Wait(Authors)
- 2015(Publication Date)
- Routledge(Publisher)
...With the positive production externality shown in Figure 17.6, the MSC is lower than the MPC by the size of the positive externality. Consequently, the market output, where MPB = MPC, resulting is an equilibrium quantity Q M less than the surplus-maximing outcome Q *. The DWL is the shaded area – for every unit between Q M and Q * the MPB > MSC ; the DWL indicates the surplus forgone in the market equilibrium relative to the efficient outcome. Figure 17.6 The market equilibrium and the socially optimal outcome in the presence of a positive production externality. The area representing Deadweight Loss is shaded 17.4 Solutions to externalities A number of solutions exist to correct the Deadweight Loss arising from an externality. In this section, we consider three solutions: (a) the Coase Theorem; (b) taxes and subsidies; and (c) standards and regulations. 17.4.1 Private-market solutions: the Coase Theorem One way that an externality may be corrected is via private bargaining between the involved parties. In this way, the market participants and the third parties affected by the externality can ‘renegotiate’ the market outcome, such that the socially optimal outcome is implemented and the Deadweight Loss is eliminated. To understand how this works, consider the following example. Example. A beekeeper and an almond grower have farms next to each other. The beekeeper’s bees provide a positive externality for the almond grower by pollinating his almond flowers, which increases almond production. If the beekeeper increases her number of hives, even more flowers will be pollinated. This suggests that if the beekeeper decides how many hives to keep based on her interests alone, this number may be fewer than is socially efficient because the almond grower also benefits from each additional hive. However, this can be addressed via private negotiation between the parties...
