Deadweight loss is loss to society.
Deadweight loss is loss to the society due to market inefficiency. When a market is efficient, the demand and supply curves intersect each other at the equilibrium point. The total consumer surplus and producer surplus is maximized. On the graph, the total surplus is the area bounded by the supply and demand curves. No deadweight loss is observed at equilibrium.
However, market efficiency can be lost due to various factors, such as overproduction or underproduction, taxes, subsidies, price ceilings and many others. Deadweight loss results and the total surplus is reduced. You can identify deadweight losses by calculating the area bounded by the equilibrium point, the supply and demand curve, and the market quantity demanded.
Instructions
1. Sketch a graph. Draw the supply and demand curves and label the intersection of the curves as the equilibrium point (Q0, P0). Then draw the market quantity demanded line that reflects market inefficiency. The market quantity demanded line intersects the supply and demand curves at (Q1, P1) and (Q1, P2).
If the market quantity demanded line is to the left of the equilibrium, shade the triangular area to the right; otherwise, shade the triangular area to the left. The shaded region is the deadweight loss.
2. Calculate the difference in quantity demanded between the quantity demanded at equilibrium and the market quantity demanded by computing |Q0-Q1|.
3. Calculate the difference in price between the supply and demand by keeping market quantity demanded constant. You can do so by computing |P1-P2|.
4. Calculate the deadweight loss. Since the deadweight loss region is a triangle, you can compute the deadweight loss by calculating 0.5 (|Q0-Q1|)(|P1-P2|).
Tags: quantity demanded, market quantity, market quantity demanded, supply demand, deadweight loss