Deadweight loss - wikipedia Deadweight loss Deadweight loss created by a binding price ceiling. The producer surplus always decreases, but the consumer surplus may or may not increase ; however, the decrease in producer surplus must be greater than the increase, if any, in consumer surplus. A deadweight loss, also known as excess burden or allocative inefficiency, is a loss of economic efficiency that can occur when equilibrium for a good or a service is not achieved. That can be caused by monopoly pricing in the case of artificial scarcity, an externality, a tax or subsidy, or a binding price ceiling or price floor such as a minimum wage. Contents 1 Examples 2 Harberger 's triangle 3 Hicks vs. Marshall 4 See also 5 References 6 Further reading 7 External links Examples An example is a market for nails where the cost of each nail is $0.10 and the demand decreases linearly, from a high demand for free nails to zero demand for nails at $1.10. If the market has perfect competition, producers would have to charge a price of $0.10, and every customer whose marginal benefit exceeds $0.10 cents would have a nail. However, if there is one producer with a monopoly on the product, it will charge whatever price will yield the greatest profit. The producer would then charge $0.60 cents and thus exclude every customer who had less than $0.60 of marginal benefit. The deadweight loss would then be the economic benefit foregone by such customers because of monopoly pricing. Conversely, deadweight loss can come from consumers if they buy a product even if it costs more than it benefits them. To describe this, if the same nail market had the government giving a $0.03 cent subsidy to every nail produced, the subsidy would push the market price of each nail down to $0.07. Some consumers would then buy nails even though the benefit to them is less than the real cost of $0.10. That unneeded expense would then create a deadweight loss, with resources not being used efficiently. The deadweight loss is the area of the triangle formed by the grey tax income box ( to the right of it ), the original supply curve, and the demand curve. It is sometimes called Harberger 's triangle. If the price of a glass of wine is $3.00 and the price of a glass of beer is $3.00, a consumer might prefer to drink wine. If the government decides to levy a wine tax of $3.00 per glass, the consumer might prefer to drink beer. The excess burden of taxation is the loss of utility to the consumer for drinking beer instead of wine since everything else remains unchanged. Harberger 's triangle Harberger 's triangle, generally attributed to Arnold Harberger, refers to the deadweight loss ( as measured on a supply and demand graph ) associated with government intervention in a perfect market. That can happen through price floors, caps, taxes, tariffs, or quotas. It also refers to the deadweight loss created by a government 's failure to intervene in a market with externalities. In the case of a government tax, the amount of the tax drives a wedge between what consumers pay and what producers receive, and the filled - in wedge shape is equivalent to the deadweight loss from the tax. The area represented by the triangle comes from the fact that the intersection of the supply and the demand curves are cut short so the consumer surplus and the producer surplus are also cut short. The loss of such surplus that is not recouped, is the deadweight loss. Some economists like James Tobin have argued that the triangles do not have a huge impact on the economy, but others like Martin Feldstein maintain that they can seriously affect long - term economic trends by pivoting the trend downwards and cause a magnification of losses in the long run. Hicks vs. Marshall An important distinction should be made between Hicksian ( per John Hicks ) and Marshallian ( per Alfred Marshall ) deadweight loss. After the consumer surplus is considered, it can be shown that the Marshallian deadweight loss is zero if demand is perfectly elastic or supply is perfectly inelastic. However, Hicks analyzed the situation through indifference curves and noted that when the Marshallian demand curve is perfectly inelastic, the policy or economic situation that caused a distortion in relative prices has a substitution effect, i.e. is a deadweight loss. In modern economic literature, the most common measure of a taxpayer 's loss from a distortionary tax, such as a tax on bicycles, is the equivalent variation, the maximum amount that a taxpayer would be willing to forgo in a lump sum to avoid the distortionary tax. The deadweight loss can then be interpreted as the difference between the equivalent variation and the revenue raised by the tax. The difference is attributable to the behavioural changes induced by a distortionary tax that are measured by a substitution effect. However, that is not the only interpretation, and Lind and Granqvist ( 2010 ) point out that Pigou did not use a lump sum tax as the point of reference to discuss deadweight loss ( excess burden ). A comparable measure of loss is the compensating variation, which depends on Hicksian demand instead of Marshallian demand. In the context of a distortionary tax, the compensating variation is the minimum lump sum transfer that makes an individual indifferent between the lump sum transfer with tax and no lump sum transfer with no tax, the original situation. The deadweight loss can then be interpreted as the minimum lump sum. See also Tax choice References Jump up ^ `` Negative Externality ''. Retrieved February 11, 2012. Jump up ^ Gruber, Jonathan ( 2013 ). Public Finance and Public Policy. New York : Worth Publishers. ISBN 978 - 1 - 4292 - 7845 - 4. Further reading Case, Karl E. & Fair, Ray C. ( 1999 ). Principles of Economics ( 5th ed. ). Prentice - Hall. ISBN 0 - 13 - 961905 - 4. Hines, James R., Jr. ( 1999 ), `` Three sides of Harberger Triangles '' ( PDF ), Journal of Economic Perspectives, 13 ( 2 ) : 167 -- 188, doi : 10.1257 / jep. 13.2. 167. Lind, H. & R. Granqvist ( 2010 ) A Note on the Concept of Excess Burden. Economic Analysis and Policy 40 : 63 - 73. External links Worthwhile Canadian Initiative `` Too much stuff : the deadweight loss from overconsumption '' Microeconomics Major topics Aggregation Bilateral monopoly Budget Consumer Convexity and non-convexity Cost Cost -- benefit analysis Deadweight loss Distribution Duopoly Economies of scale Economies of scope Elasticity Equilibria Exchange Expected utility Externality Firms General equilibrium Household Income -- consumption curve Information Indifference curve Intertemporal choice Marginal cost Market failure Market structure Monopoly Monopsony Oligopoly Preferences Production Profit Public goods Returns to scale Risk aversion Scarcity Shortage Social choice Sunk costs Supply & demand Surplus Uncertainty Utility Welfare Subfields Behavioral Business Computational Statistical decision theory Econometrics Experimental Game theory Industrial organization Labor Managerial Mathematical economics Microfoundations of macroeconomics Operations research Optimization Retrieved from `` https://en.wikipedia.org/w/index.php?title=Deadweight_loss&oldid=801879200 '' Categories : Imperfect competition Price controls Scarcity Welfare economics Talk Contents About Wikipedia Català Čeština Deutsch Español فارسی Français 한국어 Hrvatski Íslenska Italiano Македонски Nederlands Norsk Polski Português Suomi Svenska Tiếng Việt 中文 Edit links This page was last edited on 22 September 2017, at 14 : 03. 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Question: the deadweight loss from a tax is called the
Answer: excess burden