Loading the player...

What is 'Deadweight Loss'

A deadweight loss is a cost to society created by market inefficiency. Mainly used in economics, deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources. Price ceilings, such as price controls and rent controls; price floors, such as minimum wage and living wage laws; and taxation can all potentially create deadweight losses.

BREAKING DOWN 'Deadweight Loss'

Deadweight loss occurs when supply and demand are not in equilibrium. When consumers do not feel the price of a good or service is justified when compared to the perceived utility, they are less likely to purchase the item. With the reduced level of trade, the allocation of resources may become inefficient, which can lead to a reduction in overall welfare within a society.

Examples of Deadweight Losses

Minimum wage and living wage laws can create a deadweight loss by causing employers to overpay for employees and preventing low-skilled workers from securing jobs. Price ceilings and rent controls can also create deadweight losses by discouraging production and decreasing the supply of goods, services or housing below what consumers truly demand. Consumers experience shortages and producers earn less than they would otherwise.

Taxes are also said to create a deadweight loss because they prevent people from engaging in purchases they would otherwise make because the final price of the product is above the equilibrium market price.

For example, if taxes on an item rise, the burden is often split between the producer and the consumer, leading to the producer receiving less profit from the item and the customer paying a higher price. This results in lower consumption of the item than previously, which reduces the overall benefits the consumer market could have received while simultaneously reducing the benefit the company may see in regards to profits.

Market Inefficiency

Market inefficiency occurs when goods within the market are either overvalued or undervalued. While certain members of society may benefit from the imbalance, others suffer consequences in regards to their welfare.

For example, overvalued prices may lead to higher profit margins but negatively affect consumers of the product. For inelastic goods, meaning demand does not change for that particular good or service when the price goes up or down, the increased cost may prevent consumers from making purchases in other market sectors. In addition, some consumers may purchase a lower quantity of the item when possible. For elastic goods, meaning sellers and buyers quickly adjust their demand for that good or service if the price changes, consumers may reduce spending in the category to compensate or be priced out of the market entirely.

Undervalued products may be desirable for consumers but may prevent a producer from recuperating production costs. If the product remains undervalued for a substantial period, some producers may be forced out of the market.

RELATED TERMS
  1. Price Ceiling

    The price ceiling is the maximum a seller can legally charge ...
  2. Income Effect

    The income effect is the change in demand for a good or service ...
  3. Wage Push Inflation

    Wage push inflation is a general increase in the cost of goods ...
  4. Demand Theory

    Demand theory is a principle relating to the relationship between ...
  5. Demand

    Demand is an economic principle that describes consumer willingness ...
  6. Law of Supply and Demand

    The law of supply and demand explains the interaction between ...
Related Articles
  1. Investing

    What is Deadweight Loss?

    Deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources.
  2. Insights

    Introduction to Supply and Demand

    Learn about one of the most fundamental concepts of economics - supply and demand - and how it relates to your daily purchases.
  3. Personal Finance

    Minimum Wage: Good Cause Or Economic Pariah?

    Here are some positives and negatives to help you decide where you stand on the minimum wage debate.
  4. Insights

    What is Supply & Demand?

    The law of supply and demand is one of the most basic principles in economics. In simplest terms, the law of supply and demand states that when an item is scarce, but many people want it, the ...
  5. Retirement

    4 Things That Make a Stock a Risky Bet

    Risk is everywhere and when it comes to stocks it can take many forms. From price risk to volatility risk, there’s a lot investors have to look out for.
  6. Personal Finance

    The Minimum Wage: Does It Matter?

    The numbers show that a fight for a living wage is more important than a fight for a raise in minimum wage.
  7. Financial Advisor

    At What Point Does Indexing Get Top Heavy?

    More than 40% of all investment assets are now held in index funds. Are they becoming too popular?
  8. Insights

    Why $15 Minimum Wage Might Not Be Good News for Anyone (MCD, DPZ)

    Discover why the minimum wage isn't the panacea it is made out to be, and how artificial wage increases strain businesses and consumers.
  9. Personal Finance

    Are College Honor Societies Really Worth It?

    College honor societies may offer substantial benefits to members and alumni, but they are not the only way for you to achieve your goals.
RELATED FAQS
  1. Which economic factors most affect the demand for consumer goods?

    Understand how key economic factors such as inflation, unemployment, interest rates and consumer confidence affect the level ... Read Answer >>
  2. How are industrial goods different from consumer goods?

    Understand the difference between industrial goods and consumer goods, and learn the different types of industrial goods ... Read Answer >>
  3. What are some examples of inelastic goods and services that are not affected by the ...

    Find out how the laws of supply and demand function for goods and services considered highly inelastic, including goods not ... Read Answer >>
  4. What is the difference between a capital good and a consumer good?

    Learn to differentiate between capital goods and consumer goods, determined by how those goods are used, and see why capital ... Read Answer >>
Hot Definitions
  1. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  2. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  3. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  4. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  5. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  6. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
Trading Center