Deadweight loss is a cost to society created by market inefficiency, which occurs when supply and demand are out of equilibrium. Primarily used in economics, deadweight loss can be applied to any deficiencies caused by inefficient resource allocation. It is the cost of society due to the inefficiency of the market, and it is the loss of economic efficiency when the equilibrium result is not attainable or is not achieved. Deadweight loss refers to the loss of economic efficiency that results from an imbalance between supply and demand. In other words, goods and services are either undersupplied or overstocked in the market, leading to an economic loss for the nation.
The formula for deadweight loss is expressed as the area of a triangle with base equivalent to the difference between the prices of the original demand curve and the new demand curve in the new quantity demanded, and height equivalent to the difference between the equilibrium quantities of the original demand curve and the new demand curve. The concept of deadweight loss is important from an economic point of view, as it helps to assess the welfare of society. It is a measure of the inefficiency of a market, so a higher deadweight loss value indicates a greater degree of inefficiency prevailing in the market. Such losses are observed in markets characterized by oligopoly and monopoly. Deadweight losses can be caused by rent control (price ceiling), minimum wage (minimum price) and taxes. Price ceilings and rent controls can also lead to deadweight losses by discouraging production and decreasing the supply of goods, services or housing below what consumers actually demand.
The price elasticities of supply and demand determine whether the deadweight loss of a tax is large or small. Theoretically, if the redistributive tax is high enough, it should eventually reduce the possible loss of deadweight. Conversely, the loss of deadweight may also be due to consumers buying more than one product than they would otherwise based on their marginal profit and cost of production. This creates a loss of deadweight for society, as consumers are paying more than what is needed to bring to market. It also refers to the loss of dead weight created by the inability of a government to intervene in a market with externalities. Deadweight loss is generally the result of government policies, such as floor prices, price caps, taxes and subsidies.
In a competitive market, both cost and prices would be lower, and it is this difference in cost that represents a loss of deadweight for society. The deadweight loss between two points on a chart is then calculated after the supply or demand curve has shifted. Understanding this concept can help economists better understand how markets work and how government policies can affect them.