Deadweight loss

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Deadweight loss created by a binding price ceiling. Producer surplus is necessarily decreased, while consumer surplus may or may not increase; however the decrease in producer surplus must be greater than the increase (if any) in consumer surplus.

In economics, 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 service is not Pareto optimal. In other words, either people who would have more marginal benefit than marginal cost are not buying the good or service or people who would have more marginal cost than marginal benefit are buying the product.

Causes of deadweight loss can include monopoly pricing (see artificial scarcity), externalities, taxes or subsidies (Case and Fair, 1999: 442), and binding price ceilings or floors. The term deadweight loss may also be referred to as the "excess burden of monopoly" or the "excess burden of taxation".

Example

Hicks vs. Marshall

An important distinction should be drawn between Hicksian and Marshallian deadweight loss. The latter is related to the concept of consumer surplus, such that it can be shown that the Marshallian deadweight loss is zero where demand is perfectly elastic or supply is perfectly inelastic. On the other hand, Hicks analyzed the situation through indifference curves and noted that when the Marshallian Demand Curve exhibits perfect inelasticity, the policy or economic situation which caused a distortion in relative prices will have an income effect and that this income effect is a deadweight loss.

References

• Case, Karl E. & Fair, Ray C. (1999). Principles of Economics (5th ed.). Prentice-Hall. ISBN 0-13-961905-4.