Deadweight Loss Guide: 7 Causes of Deadweight Loss

Deadweight loss refers to an economic inefficiency created by an imbalance in supply and demand. Deadweight loss disrupts the natural market equilibrium with customers losing out on products that they demand, and businesses losing out on potential revenue from their supply.
It refers to missed economic opportunities between traders that can cause an overall economic loss for society. This can happen when businesses gouge their prices above the equilibrium price, when regulatory bodies impose price controls, or when high sales taxes impose excess fees on top of the price of the product.

Deadweight loss occurs when a trade no longer benefits the traders. It is generally created by conditions that impact consumer access to a product, which in turn applies an excess burden to sellers that are losing out on sales. Here are some common causes of deadweight loss.

1. 1. Product surplus: Too many products and too little demand can be detrimental to a country’s economic health. With too many goods on the market, money is tied up in the total surplus of products that sit dormant in company storage instead of circulating in the market. Products that have high elasticity—with the demand changes in accordance with the price—are the ones affected by this mechanism. Producer surplus can lead to decreased consumer demand, perpetuating the cycle of missed economic opportunities.
2. 2. Product deficit: Not having enough products to service interested consumers can also result in a lack of business, which means missed financial opportunities for both parties. If there is a consumer surplus and a product deficit, a business may lose out on future business, perpetuating a financially detrimental cycle.
3. 3. Taxes: Sales taxes help the government gather tax revenue for various services, but they can also make necessary goods more expensive for the end-user. These customers may lose confidence that the product is worth the higher price, thus shifting the demand curve down and impacting a business’ sales.
4. 4. Price ceilings: A price ceiling is when the government puts a maximum price on how much someone can spend for a particular product. This can adversely affect the economy and create an ineffective outcome, as consumers will want to pay lower prices for goods, but businesses will be unwilling to reduce the price of those goods. Although price ceilings can be a useful tool to protect consumers from price gouging, they can also reduce a business’s ability to make money by limiting the supply of products available for consumers to buy. One example of a price ceiling is rent control, which places a limit on how much rent that landlords can charge in a given location. This means that landlords can only earn so much from the tenant, making them more likely to sell their rent-controlled apartments as permanent residences. This means fewer rental properties to serve the demand of aspiring renters, creating missed economic opportunities all around.
5. 5. Price floors: A price floor is when the government sets a minimum price for goods or services, which can lead to market inefficiency. Minimum wage is an example of a price floor, although it is an important regulatory measure to prevent the exploitation of workers. When the minimum wage rises, prices of goods also increase so that businesses can pay for the higher cost of wages. This may also mean that businesses refuse to hire low-skilled workers to whom they would pay minimum wage, creating fewer opportunities for people who are just starting out.
6. 6. Monopolies: Monopolies (when one company controls the entire market for a product) and oligopolies (when multiple companies band together to keep product prices high) create deadweight loss for society by being the sole controllers of the market price of a certain good. This enables businesses to gouge prices because consumers don’t have other options to turn to. Without a competitive market, monopolists and oligopolists are free to conduct business as they see fit because consumers are essentially forced to pay monopoly pricing in order to obtain their goods.
7. 7. Subsidies: Governments that provide money to businesses can contribute to deadweight loss. By providing subsidies, the government pads a business’s finances so that they may offer better deals and opportunities to customers, which in turn should attract more customers. However, this only leads to an artificial rise in demand.

You need to take a round-trip train ride from New York to Washington D.C. In the past, you’ve paid $150 for this train ticket, which is how much you value the trip. When you check the prices, this same ticket is $130 dollars, making the total added value of this trip $20 dollars.

The next day, regulations change and the government is imposing a new tax of 50 percent on all public ground transportation. This means that your ticket now costs $195 instead of $130, erasing the previously added value. You decide not to buy the ticket because of the new price, meaning a missed opportunity for you and an economic loss for the train company.

Deadweight loss is calculated by multiplying the change in product quantity by the change in the product price in an economic circumstance that doesn’t result in a sale. Then, you divide that figure by two. The formula for calculating deadweight loss is: deadweight loss = (new price - old price) x (original quantity - new quantity) / 2. By using this equation, you can see just how far the new price of the product has changed from its original. The greater the difference, the larger the deadweight loss.

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