2. WHAT IS DEADWEIGHT
LOSS ?
Deadweight loss refers to the cost borne by
society when there is an imbalance between
the demand and supply. It is a market
inefficiency that is caused by the improper
allocation of resources.
3. EXPLANATION:
A deadweight loss is a market inefficiency caused by a mismatch
between goods consumption and demand. Due to the inefficiency,
products are either overvalued or undervalued.
Graph :
4. CAUSES OF DEADWEIGHT LOSS
1.Price ceiling - The government ascertains a maximum price for
products to prevent overcharging. However, price ceilings
discourage sellers, as it curtails the possibility of earning high
returns. Thus, price ceilings bring down goods supply.
2.Price floor - Often, the government fixes a minimum selling price
for goods. This increases product prices. Similarly, governments
often fix a minimum wage for laborers and employees. But high
wages result in job loss for incompetent employees.
5. 3. Monopoly - When a single market player has a monopoly, the
regulation of goods price and supply is unnatural. The selling price
set by the monopolist is significantly higher than the marginal cost &
the market becomes inefficient. Further, if customers are unable to
afford the product or service & demand falls.
4. Taxation - When the government raises the taxes on certain
goods or services, it influences the price and demand for that
product. When taxes raise a product’s price, its demand starts falling.
But this cuts into producers’ profit margin.
6. 5. Subsidy - Governments provide subsidies on certain goods or
services, bringing the price down. As a result, the product demand
rises. However, this artificially created demand drives consumers to
buy a particular commodity in more quantity.
6. Product surplus - When the market is flooded with excessive
goods and the demand is low, a product surplus is created. When
demand is low, the commodity’s price falls. Manufacturers incur
losses due to the gap between supply and demand.
7. CALCULATION OF DEADWEIGHT LOSS:
or,
Here,
•∆P is the price difference.
•∆Q is the difference in the quantity demanded.
•P1 is the original price.
•Q1 is the original quantity.
•P2 is the new price.
•Q2 is the new quantity.
8. EXAMPLE:
Let us assume that economic equilibrium will be achieved for a
product at the price of $8.The demand at this price is 8000 units.
The government then imposes a price floor; the price is increased
to $10. At this price, the expected demand falls to 7000 units.
Based on the given data, calculate the deadweight loss.
Solution:
Dead weight = 0.5 * (P2-P1) * (Q1-Q2)
= 0.5 * (10-8) * (8000-7000)
= $1000
Thus, due to the price floor, manufacturers incur a loss of $1000.
