Cambridge International as and a level Economics Ebook

Deadweight loss: 
the welfare loss when due to market failure 
desirable consumption and production does not take place.
KEY TERM
Quantity
0
Price
MC
AR
Q
2
Q
1
MR
P
2
P
1
Figure 8.2 
Deadweight loss under monopoly
Figure 8.1 
Allocative eff iciency
P
e
0
Price
Quantity
Q
e
S
= MPC
D
= MPB
191
Chapter 8: Government microeconomic intervention

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Deadweight loss can also be seen to operate when a 
government imposes an indirect tax on a product. Th
is is 
shown in 
Figure 8.3.
Th
e price and quantity of the product are given by 
the intersection of supply and demand before the tax is 
imposed. Th
is gives a price of 
P
1
and a quantity of 
Q
1
. Th
e 
imposition of the tax is the equivalent of an increase in 
the costs of production and thus it shift s the supply curve 
to the left (
S 
to
 S
1
). Th
is leads to a higher price, 
P
2
, and a 
lower quantity, 
Q
2
. Th
is means a deadweight loss for the 
same reason as in a monopoly. Desirable production and 
consumption are discouraged because of the higher price. 
Th
e resulting overall loss of economic welfare is shown 
by the shaded triangle. It gives a measure of the amount 
of deadweight loss due to the imposition of the tax. From 
a wider perspective, excessive taxes can undermine 
competitiveness in a market.
Government intervention to