Dead weight loss

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 by 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.

An example is if a market for nails has the cost of each nail is $0.10 and the demand linearly from a high demand for free nails to zero demand for nails at $1.10. If the market has perfect competition market, 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 then 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.

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, 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.

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