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Deadweight Loss

Economics (Year 11) - Market Efficiency

Ben Whitten

What is deadweight loss?

Deadweight loss is the difference between the actual level of welfare generated in a market and the maximum possible level of welfare.

When will deadweight loss occur?

It occurs when markets do not operate at the most efficient point. This may happen as, for some reason, the market is not operating at the equilibrium point. There may be under or over production, and prices may be set above or below the equilibrium price.

Does market failure result in deadweight loss too?

Yes – market failure means resources are not being allocated to markets in an optimal manner, and, as a result, community surplus or welfare is not being maximised. This can happen when producers have a degree of monopoly power, their production generates positive or negative production externalities, or they ‘satisfy’ rather than aim for maximum profits. This can also happen when consumers’ decisions are based on bounded rationality, due to limited or incorrect information, as they suffer from cognitive biases or as their consumption creates positive or negative externalities.

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