Definition of a Deadweight Loss:

A deadweight loss is the loss of economic efficiency that occurs when the marginal benefit does not equal the marginal cost
resulting from a regulation, tax, subsidy, externality, or monopolistic pricing.

Detailed Explanation:

A deadweight loss is the added burden placed on consumers and suppliers when the market equilibrium is altered because of
tax, subsidy, externality, government regulation, or monopolistic pricing. A deadweight loss results when the supply and
demand are out of equilibrium.

The greatest market efficiency occurs when the sum of the consumer surplus and producer surplus is maximized. Graphically
this is where the supply and demand curves intersect. Graphs 1 and 2, the supply and demand for bottled water, illustrate a
deadweight loss. The sum of producer and consumer surpluses is equal to the shaded areas on Graph 1, where APB is the
consumer surplus and PBC is the producer surplus. The total surplus equals ABC.

When the production is less than optimal, (Q1 on Graph 2), there is a shortage and a loss of efficiency. This loss is the area ABC,
with AFC being the loss of consumer surplus and CFB resulting from a producer surplus loss. At Q2 there is a surplus.
Overproduction results in a loss of efficiency. The total loss is CDE, with CDG being the producer surplus loss and CGE being the
consumer surplus loss.

Economists refer to this loss as a deadweight loss. A loss of efficiency from overproduction means that too many resources
have been allocated to the production. When there is a shortage, society would like more resources allocated to produce a
good or service. Deadweight loss is a measure of the efficiency lost from production levels that are less than or more than
society’s optimal production level (as defined by where the supply and demand curves intersect). Deadweight loss can be
measured by the reduction in consumer and producer surpluses. In other words, at quantities less than the optimal, suppliers
are “leaving some money on the table” by not producing the amount society would be willing to purchase, so there is a loss to
producers. Consumers are paying more than they would need to so they too lose. When more is produced than is socially
desirable, higher-cost producers lose money, so there is a loss of producer surplus, while consumers pay more than they need
to at the larger quantity.
Government policies such as the minimum wage result in a surplus of workers. The social cost is the increase in unemployment
because the minimum wage exceeds the equilibrium wage. Rent control causes a shortage of housing because the lower than
market rent increases the number of families seeking housing while reducing the number of investors willing to provide rental
units. The deadweight loss is the social cost resulting from the shortage of housing.

Taxes that shift the supply curve result in a deadweight loss. A deadweight loss is determined by assessing the loss of
production and the higher price when the tax alters the market equilibrium. There is a social cost caused by the inefficient
allocation of resources. For example, two costs resulting from an excise tax are included in the deadweight loss. First, the
equilibrium price increases because the tax pushes the equilibrium price higher. Second, there is also a drop in the equilibrium
quantity. A deadweight loss is determined by assessing the loss of production and the higher price when the tax alters the
market equilibrium.

What is deadweight loss from overproduction?

This happens when there are too little items produced (underproduction), or when too much items are produced
(overproduction). Deadweight Loss: is the decrease in total surplus from the inefficient level of production.
1. What is a deadweight loss? 2 points
A deadweight loss is the loss of economic efficiency that occurs when the marginal benefit does not equal the marginal
cost resulting from a regulation, tax, subsidy, externality, or monopolistic pricing.
2. Explain with at least one example. 2 points
A deadweight loss is the added burden placed on consumers and suppliers when the market equilibrium is altered
because of tax, subsidy, externality, government regulation, or monopolistic pricing. A deadweight loss results when
the supply and demand are out of equilibrium.
3. When does the greatest market efficiency occur? 2 points
The greatest market efficiency occurs when the sum of the consumer surplus and producer surplus is maximized.
Graphically this is where the supply and demand curves intersect.

4. Explain the supply and demand for bottles of water every month. – 2 points
Graphs 1 and 2, the supply and demand for bottled water, illustrate a deadweight loss. The sum of producer and
consumer surpluses is equal to the shaded areas on Graph 1, where APB is the consumer surplus and PBC is the
producer surplus. The total surplus equals ABC.
5. When there is a loss of producer surplus happens, it means? – 2 points
When the production is less than optimal, (Q1 on Graph 2), there is a shortage and a loss of efficiency. This loss is the
area ABC, with AFC being the loss of consumer surplus and CFB resulting from a producer surplus loss. At Q2 there is a
surplus. Overproduction results in a loss of efficiency. The total loss is CDE, with CDG being the producer surplus loss
and CGE being the consumer surplus loss.
6. What is the effect of government policies on wages? 2 points
Government policies such as the minimum wage result in a surplus of workers. The social cost is the increase in
unemployment because the minimum wage exceeds the equilibrium wage. Rent control causes a shortage of housing
because the lower than market rent increases the number of families seeking housing while reducing the number of
investors willing to provide rental units. The deadweight loss is the social cost resulting from the shortage of housing.
7. What is the effect of taxes on the supply curve? 2 points
Taxes that shift the supply curve result in a deadweight loss. A deadweight loss is determined by assessing the loss of
production and the higher price when the tax alters the market equilibrium. There is a social cost caused by the
inefficient allocation of resources. For example, two costs resulting from an excise tax are included in the deadweight
loss. First, the equilibrium price increases because the tax pushes the equilibrium price higher. Second, there is also a
drop in the equilibrium quantity. A deadweight loss is determined by assessing the loss of production and the higher
price when the tax alters the market equilibrium.
8. What is deadweight loss from overproduction? 2 points
This happens when there are too little items produced (underproduction), or when too much items are produced
(overproduction). Deadweight Loss: is the decrease in total surplus from the inefficient level of production.
9. Give at least 2 examples – 4 points
For example, two costs resulting from an excise tax are included in the deadweight loss. First, the equilibrium price
increases because the tax pushes the equilibrium price higher. Second, there is also a drop in the equilibrium quantity.