Deadweight loss
In economics, deadweight loss is the loss of societal economic welfare due to production/consumption of a good at a quantity where marginal benefit (to society) does not equal marginal cost (to society) – in other words, there are either goods being produced despite the cost of doing so being larger than the benefit, or additional goods are not being produced despite the fact that the benefits of their production would be larger than the costs. The deadweight loss is the net benefit that is missed out on. While losses to one entity often lead to gains for another, deadweight loss represents the loss that is not regained by anyone else. This loss is therefore[1] attributed to both producers and consumers.
"DWL" redirects here. For other uses, see DWL (disambiguation).Deadweight loss can also be a measure of lost economic efficiency when the socially optimal quantity of a good or a service is not produced. Non-optimal production can be caused by monopoly pricing in the case of artificial scarcity, a positive or negative externality, a tax or subsidy, or a binding price ceiling or price floor such as a minimum wage.
Hicks vs. Marshall[edit]
The Hicksian (per John Hicks) and the Marshallian (per Alfred Marshall) demand function differ about 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 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 behavioral changes induced by a distortionary tax that are measured by the substitution effect. However, that is not the only interpretation, and Pigou did not use a lump sum tax as the point of reference to discuss deadweight loss (excess burden).[4]