Understanding and Finding the Deadweight Loss

Deadweight Loss
In economics, deadweight loss is a loss of economic efficiency that occurs when equilibrium for
a good or service is not Pareto optimal. When a good or service is not Pareto optimal, the
economic efficiency is not at equilibrium. As a result, when resources are allocated, it is
impossible to make any one individual better off without making at least one person worse off.
When deadweight loss occurs, there is a loss in economic surplus within the market.
Deadweight loss implies that the market is unable to naturally clear.

Key Terms

 equilibrium: The condition of a system in which competing influences are balanced,

resulting in no net change.

 deadweight loss: A loss of economic efficiency that can occur when equilibrium for a
good or service is not Pareto optimal.

Causes of Deadweight Loss

Deadweight loss is the result of a market that is unable to naturally clear, and is an indication,
therefore, of market inefficiency. The supply and demand of a good or service are not at
equilibrium. Causes of deadweight loss include:
• imperfect markets
• taxes or subsides
• price ceilings
• price floors
Graphically Representing Deadweight Loss
Consider the graph below:

At equilibrium, the price would be $5 with a quantity demand of 500.

Equilibrium price = $5
Equilibrium demand = 500
Let us consider the effect of a new after-tax selling price of $7.50:

The price would be $7.50 with a quantity demand of 450.

With this new tax price, there would be a deadweight loss:

Calculating Deadweight Loss

To figure out how to calculate deadweight loss from taxation, refer to the graph shown below

The deadweight loss is represented by the blue triangle and can be calculated as follows:
Deadweight Loss Formula: Deadweight Loss = ½ x (P2 – P1) x (Q0 – Q1)