A Deadweight Loss

 A deadweight loss is a cost to society created by market inefficiency,

 It will occurs supply and demand are out of equilibrium, an inefficient market is one in which an
asset's prices do not accurately reflect its true value,
 In reality, most markets do display some level of inefficiencies, and in the extreme case an inefficient
market can be an example of a market failure.

Major Causes of Deadweight Loss

Price floors: Price ceilings:

The government sets a limit on how low a price The government sets a limit on how high a price
can be charged for a good or service. can be charged for a good or service.

An example of a price floor would be minimum
wage.
Undervalued products may be desirable for
consumers but If the product remains
undervalued for a substantial period, producers
will either choose to no longer sell that product,
up the price to equilibrium, or may be forced out
of the market entirely.
An example of a price ceiling would be rent
control – setting a maximum amount of money
that a landlord can collect for rent.
Overvalued prices may lead to higher profit
margins for a company, but it negatively affects
consumers of the product.
The increased cost may prevent consumers from
making purchases in other market sectors. In
addition, some consumers may purchase a lower
quantity of the item when possible.

Taxation:
The government charging above the selling price
for a good or service.
An example of taxation would be a cigarette tax.
Monopolies:
Monopolies occur when one business owns the
whole of the market. That allows it to dictate price
and the quantity it supplies to the market.

Taxes also create a deadweight loss because they
prevent people from engaging in purchases. The
burden is often split between the producer and the
consumer, leading to the producer receiving less
profit from the item and the customer paying a
higher price.
In a monopoly, a single supplier controls the
entire supply of a product. Demand for the
product remains relatively stable no matter how
high (or low) its price goes. Supply can be
restricted to keep prices high. This leads to under
provision, or scarcity.
 Calculation of Deadweight Loss

 The equilibrium price and quantity before the imposition of tax are Q0 and P0.
 With the tax, the supply curve shifts by the tax amount from Supply0 to Supply1. Producers
would want to supply less due to the imposition of a tax.
 The buyer’s price would increase from P0 to P1
 And the seller would receive a lower price for the good from P0 to P2.
 Due to the tax, producers supply less from Q0 to Q1.

The deadweight loss is represented by the blue triangle and can be calculated as follows:

Deadweight Loss= ½*(P2-P1) X (Q0-Q1)

Example of Deadweight Loss

1. A new sandwich shop opens selling a sandwich for $10. You perceive the value of this
sandwich to be $12 and, therefore, are happy to pay $10 for it. Now, assume the government
imposes a new sales tax on food items which raises the cost of the sandwich to $15. At $15, you feel
that the sandwich is overvalued and believe that the new cost is not a fair price and, therefore, are
not willing to buy the sandwich at $15.

Many consumers, but not all, feel this way about the sandwich and the sandwich shop sees
a decrease in demand for its sandwich and a decline in revenues. The deadweight loss in this
example is the unsold sandwiches as a result of the new $15 cost. If the decrease in demand is
severe enough, the sandwich shop could go out of business, further increasing the negative
economic effects of the new tax.
 2. Imagine that you want to go on a trip to Vancouver. A bus ticket to Vancouver costs $20,
and you value the trip at $35. In this situation, the value of the trip ($35) exceeds the cost ($20) and
you would, therefore, take this trip. The net value that you get from this trip is $35 – $20 (benefit –
cost) = $15.

Prior to buying a bus ticket to Vancouver, the government suddenly decides to impose a
100% tax on bus tickets. Therefore, this would drive the price of bus tickets from $20 to $40. Now,
the cost exceeds the benefit; you are paying $40 for a bus ticket from which you only derive $35 of
value.

In such a scenario, the trip would not happen, and the government would not receive any
tax revenue from you. The deadweight loss is the value of the trips to Vancouver that do not
happen because of the tax imposed by the government.