Deadweight Loss Calculator

The deadweight loss calculator helps you calculate how taxes or price changes can make economic situations less efficient. It’s a simple way to analyze and understand the impact of these factors on overall economic well-being.

What is meant by deadweight loss?

Deadweight loss occurs when the quantity of supply and demand are not in an equilibrium state, which leads to inefficiency in the market.

Market inefficiency occurs when goods within the market are either overvalued or undervalued. While certain members of society may benefit from the imbalance, others will be negatively impacted by a shift from equilibrium.

Example:

Imagine you have a cake, if everyone gets a fair slice of that cake then everyone enjoys it. But if someone takes a bigger slice than their fair share, others get less and the overall enjoyment is reduced. That's kind of like what happens with deadweight loss.

Deadweight loss formula:

The formula for calculating deadweight loss can be simplified as:

DWL = (new price - original price) x (original quantity - new quantity) / 2.

Example of deadweight loss:

Suppose the original price of a product was $10, and the original quantity sold was 100 units. The new price due to a tax increase is $12, and the new quantity sold decreases to 80 units.

To calculate deadweight loss, let's put these values into the dead-weight loss formula:

• • DWL = (12 - 10) x (100 - 80) / 2
  • DWL = (2) x (20) / 2
  • DWL = 40 / 2

• DWL = 20

So, the deadweight loss for the given data would be $20.

How to calculate deadweight loss on a graph?

Calculating deadweight loss on a graph involves understanding the changes in supply and demand due to a particular economic policy, such as a tax or subsidy. The deadweight loss is the triangular area between the supply and demand curves caused by the policy-induced change in quantity and price. 

The steps are as follows:

• 1. Identify Equilibrium: On the graph, locate the initial equilibrium where the supply and demand curves intersect. This point represents the quantity and price in the absence of the policy.

• 2. Impact of Policy: Determine how the policy (e.g., tax) affects the market. This might shift the supply or demand curve, leading to a new equilibrium.

• 3. Locate New Equilibrium: Identify the new equilibrium point after the policy is applied. This involves finding where the new supply or demand curve intersects the other.

• 4. Calculate Deadweight Loss Area: The deadweight loss is the triangular area formed by the initial equilibrium, the new equilibrium, and the points where the supply and demand curves intersect.

You can use the formula for the area of a triangle: 

Deadweight Loss = 1/2 × Base × Height

• Base is the change in quantity (Q) between the initial and new equilibriums.
• Height is the price difference (P) between the initial and new equilibriums.

A higher deadweight loss indicates greater inefficiency in the market due to external factors.

Example:

Suppose a tax reduces the quantity traded and increases the price. The base is the quantity reduction, and the height is the price increase.

What causes deadweight loss?

Deadweight losses primarily occur due to inefficient resource allocation caused by various interventions in a market. These interventions can include:

• Price Ceilings: When a maximum price is set below the market equilibrium, it can result in shortages and reduced overall economic welfare.

• Price Floors: Setting a minimum price above the equilibrium can lead to surpluses and decreased consumer and producer surpluses.

• Monopolies: Lack of competition can lead to monopolies, where a single entity controls the market, resulting in higher prices and reduced consumer surplus.

• Taxes: Imposing taxes can distort the market equilibrium, leading to decreased trade and economic efficiency.

These factors disturb the product’s price in the market which causes goods to be either overvalued or undervalued. Therefore, the resulting inefficiencies contribute to deadweight losses in the overall economy.