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DEADWEIGHT LOSS

Definition

Deadweight loss refers to a loss in total surplus due to market distortion. This happens due to disequilibrium in demand and supply. there are several factors of disequilibrium of demand and supply. price ceiling ( price control and rent control); price floor ( minimum wage, minimum support price);    tax imposed by government ( quantity tax) can also be the reason of deadweight loss. These factors negatively impact in market, causes overvalued or undervalued of goods and services, which leads to market inefficient or market failure. 

We can understand the deadweight loss by an appropriate diagram. As shown below.

DEADWEIGHT LOSS DUE TO QUANTITY TAX
DEADWEIGHT LOSS DUE TO QUANTITY TAX IMPOSED BY GOVT.

(Pe - Equilibrium price ; Pb - Price paid by buyers ; Ps - Price received by sellers.)

(Qe - Equilibrium Quantity ; Q' - Changed quantity.)

Consumer Surplus Loss

It means loss in consumer surplus due to increase in govt revenue which increases the price paid by consumer. Some of the consumer left the market due to increased price. remaining of them are forced to pay higher price. It is denoted by area bound by B & C . which is negative. i.e (-B & -C ).

Producer Surplus Loss

It means loss in producer surplus due to increase in govt revenue which results, less price received by producer. Due to this some of the producers left the market and remaining continue with the lesser price. Which reduced the revenue of of producer's. It is denoted by area bounded by D & E. Which is negative. i.e ( -D & -E ).

Increase in Govt Revenue

It means revenue of govt which is positive. i.e (B & E ).

Net Result

Loss in consumer surplus + Loss in producer surplus + Govt. Revenue collection
= Area( -B - C -D -E + B + E )
= Area(- C - D )

Net societal loss or deadweight loss is area of ( -C - D )

Numerical

DEADWEIGHT LOSS

 = (1/2 × Size of Tax × Change in quantity)
 = { 1/2 × (Pb-Ps) × (Qe-Q') }

(Pb = Price paid by buyers.

Ps = Price received by sellers.

Pb-Ps = Difference b/w price paid by buyers and price received by sellers ( TAX SIZE)

Qe = Equilibrium quantity

Q' = Changed quantity

Qe-Q' = Difference in quantity)

Factors Affecting Deadweight Loss

Tax Rate

Tax is one of the tools of fiscal policy, which is imposed by government. it is used for to maintain stability in price or inflation. it is one of the source of revenue for government. but its reduces the societal surplus, resulted, deadweight loss.
  • Direct/Positive relationship between Tax size and deadweight loss.
  • As increase in tax size, deadweight loss increases and vice-versa.
  • If tax size = 0; then deadweight loss = 0.

Elasticity of demand and supply

Elasticity refers to degree of responsiveness to change in price to change in quantity. Perfect elasticity of demand and supply means slightly change in price tends to higher change in quantity.

Inelastic means change in price doesn't effect or very slightly effect in quantity. If demand and supply is perfect elastic it means higher the deadweight loss and if demand and supply is inelastic it means lower change in deadweight loss.

Price Ceiling 

It refers to maximum price charged by sellers for their goods and services. It sets below the market price to protect consumer. So that producer's are forcefully liable to sell their products at below market price. They shown unwillingness to sell more quantity at low price, but couldn't do anything. It reduces producer's surplus, resulted, deadweight loss. price control and rent controls are examples of price ceiling.

Price Floor

Its refers to minimum price paid for goods and services by buyers. it is always set above the market price. minimum support price ( MSP ) supports producers of goods and services ( specifically agricultural farmers ), and minimum wage rate supports workers/Labours. So that consumers/buyers/employers are liable to purchase at higher price than market price. Which reduces consumer surplus. resulting, deadweight loss.

Monopoly

Monopoly is a market structure in which, sole producers of any specific product . In this market sellers cannot compete with others firm. a monopoly have a significant market power. Getting an abnormal profit , a monopoly firm always charges above the equilibrium price. this action of monopoly firm reduces the consumer surplus, resulted, deadweight loss.








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