Deadweight loss refers to the economic inefficiency that occurs when the equilibrium for a good or service is not achieved or is not achievable. This inefficiency leads to a loss of economic welfare, which is the difference between what consumers are willing to pay for a good or service and the actual cost of producing it.
Deadweight loss typically arises under various conditions, such as:
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Taxes: When a government imposes a tax on a good or service, it can increase the price for consumers and decrease the price received by producers. This results in a reduction in the quantity traded, leading to a loss of consumer and producer surplus.
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Price Ceilings or Floors: Imposing a price ceiling (maximum price) or price floor (minimum price) can prevent the market from reaching equilibrium. For example, a price ceiling that is set below the market equilibrium price can lead to shortages, while a price floor above the equilibrium can lead to surpluses.
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Monopolies: When a single producer dominates a market, they may restrict output to raise prices, leading to lower quantities sold compared to a competitive market, which results in lost welfare.
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Externalities: When external costs (negative externalities) or benefits (positive externalities) are present but not reflected in the market price, the allocation of resources becomes inefficient, leading to deadweight loss.
Overall, deadweight loss represents an erosion of economic efficiency and indicates that there are potential gains from trade that are not being realized.
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