Deadweight Loss:
Sources and Solutions
David A. Anderson
Centre College
Chief Reader
Deadweight Loss
• What is it?
• How do we teach it?
• What do the AP questions on DWL look like?
Defining Deadweight Loss
“Losses associated with quantities of output
that are greater than or less than the efficient
level, as can result from market intervention
such as taxes, or from externalities such as
pollution.”
– Krugman’s Economics for AP, p. G-3
In the Absence of Externalities
Price
SUPPLY = MSC
25
Consumer Surplus
20
15
10
Producer Surplus
5
DEMAND = MSB
0
10
20
30
Quantity
Deadweight Loss of
Underproduction
Price
SUPPLY = MSC
25
Deadweight
loss
20
15
10
5
DEMAND = MSB
0
10
20
30
Quantity
Deadweight Loss Caused by a Tax
SUPPLY with TAX
Price
SUPPLY = MSC
2.50
Per-unit Tax
2.00
1.50
1.00
0.50
DEMAND = MSB
0
10
20
30
Quantity of Soda
Deadweight Loss Caused by a Quota
Price
QUOTA
Amount
25
SUPPLY = MSC
20
15
10
5
DEMAND = MSB
0
10
20
30
Quantity of Taxi Rides
Deadweight Loss Caused by a Price Floor
Price
SUPPLY = MSC
2.50
Price FLOOR
2.00
1.50
1.00
0.50
DEMAND = MSB
0
10
20
30
Quantity of Milk
Deadweight Loss Caused by a Price Ceiling
Price
SUPPLY = MSC
2500
2000
1500
Price CEILING
1000
500
DEMAND = MSB
0
10
20
30
Quantity of Apartments
Deadweight Loss Caused by a Positive Externality
Price
SUPPLY = MSC
25
20
15
10
Marginal
External
Benefit
5
Marginal Social Benefit
DEMAND
0
10
20
30
Quantity of Vaccinations
Deadweight Loss of Overproduction
Price
SUPPLY = MSC
25
Deadweight
loss
20
15
10
5
DEMAND = MSB
0
10
20
30
Quantity
The “Arrow” Points to the
Socially Optimal Quantity
Price
SUPPLY = MSC
25
20
15
10
5
DEMAND = MSB
0
10
20
30
Quantity
Deadweight Loss of
Underproduction
Price
SUPPLY = MSC
25
20
15
10
5
DEMAND = MSB
0
10
20
30
Quantity
The Deadweight Loss of Christmas
Joel Waldfogel, American Economic Review, 1993,
vol. 83, issue 5, pp. 1328-36.
Price
SUPPLY = MSC
25
20
15
10
5
DEMAND = MSB
0
10
20
30
Fruit Cakes
Deadweight Loss of Overproduction
Due to an Externality
Price
Social Marginal Cost
5
Marginal External Cost
4
SUPPLY
3
2
1
DEMAND
0
10
20
30
Quantity of Gasoline
$/unit
0
1
2
3
Quantity of Cola
$/unit
Demand
(additional
benefit per
unit)
0
1
2
3
Quantity of Cola
$/unit
Supply
(additional
cost per
unit)
0
1
2
3
Quantity of Cola
$/unit
Supply
Demand
0
1
2*
3
Quantity of Cola
True Additional
Cost per Unit =
Marginal Social
Cost
$/unit
Supply
Demand
0
1*
2
3
Quantity of Cola
Marginal
Social Cost
$/unit
Supply
Demand
0
1*
2
3
Quantity of Cola
Marginal
Social Cost
$/unit
Deadweight
loss
Supply
Demand
0
1*
2
3
Quantity of Cola
Teaching Net Gains
Utility Gains from a Sack Lunch
• Time required: 10-15 minutes
• Materials: Each person needs one or more
random knick-knack worth about 25 cents
(lunch sack optional).
How Happy Are You?
• With what you brought?
How Happy Are You?
• With what you brought?
• After Trading with Neighbors
How Happy Are You?
• With what you brought?
• After Trading with Neighbors
• After Trading with Anyone
The Gains from Trade
• The net gains enjoyed when trade can occur,
• And the increases in those net gains when
more trade can occur,
• Are the types of gains foregone as
DEADWEIGHT LOSS when the amount of trade
is reduced by quotas, taxes, price ceilings, and
price floors.
Teaching Externalities
THE ECOMEDY CLUB
• Time required: 15-20 minutes
• Materials required:
– 2 random books, identical or not
– 10 knock-knock jokes
How to Play
This experiment involves:
2 independent producers of human capital
(memorizers) and
2 joint consumers of humor (comedians).
The comedians sit on opposite sides of the
room, with the memorizers seated roughly in
the middle.
How to Play
The memorizers’ goal is to memorize as
many consecutive words in a randomly
selected sentence as they can in 30
seconds.
• First with silence
• Then with comedy
Knock Knock!
Who’s there?
Amos.
Amos who?
Amosquito just bit me!
Knock Knock!
Who’s there?
Andy.
Andy who?
Andy bit me again!
Knock Knock!
Who’s there?
House.
House who?
House it going?
Knock Knock!
Who’s there?
Olive.
Olive who?
Olive You!
Knock Knock!
Who’s there?
Sarah.
Sarah who?
Sarah doctor in the house?
Knock Knock!
Who’s there?
Boo.
Boo who?
Stop crying, it’s just a joke!
Knock Knock!
Who’s there?
Goat.
Goat who?
Goat to the door and find out!
Knock Knock!
Who’s there?
Leaf.
Leaf who?
Leaf me alone!
Knock Knock!
Who’s there?
Justin.
Justin who?
Justin time for supper!
Knock Knock!
Who’s there?
Les.
Les who?
Les go for a swim!
You will find that there are negative
externalities from comedy!
Source
• David Anderson and James Chasey, Favorite
Ways to Learn Economics 3e, Worth
Publishers, 2011.
SCORING GUIDELINES
(d) 1 point:
• One point is earned for concluding that, owing
to the tax, the market is no longer allocatively
efficient AND that total surplus decreases or the
tax creates a deadweight loss.
2011 AP Questions
10. Overseas Micro 2 (a)(iii)
Question: Suppose research shows that the
more college education individuals receive,
the more responsible citizens they become
and the less likely they are to commit crimes.
(a) Draw a correctly labeled graph for the
education market and show …
(iii) Deadweight loss at the market
equilibrium, completely shaded.
PRICE
Deadweight loss from
underproduction
Supply = Marginal Social Cost
PM
Marginal Social Benefit
Demand = Marg. Private Ben.
0
QM QS
Quantity of Educations
5. Overseas Micro 2 part (b)
Question: Assume that the government imposes
an effective (binding) price ceiling on the price
of college education.
(ii) Does this price ceiling increase, decrease, or
have no impact on the deadweight loss in this
industry? Explain.
PRICE
Supply = Marginal Social Cost
PM
Marginal Social Benefit
Demand = Marg. Private Ben.
0
QM QS
Quantity of Educations
PRICE
Supply = Marginal Social Cost
P1
PM
PCeiling
Marginal Social Benefit
Demand = Marg. Private Ben.
0
QC
QM QS
Quantity of Educations
5. Overseas Micro 2 part (b)
Answer: Deadweight loss will increase because
the quantity supplied will decrease.
1. Micro 3 (a)
Question: Draw a correctly labeled graph of the
market for good X [known to create a negative
externality] and show …
(iv) The area of deadweight loss, shaded
completely
Answer:
PRICE
Deadweight loss
from over
production
Marginal Social Cost
Marginal Private Cost
Demand = MSB
QS
4.1% answered correctly
QM
Market
Quantity
QUANTITY
2010 AP Question
PRICE
The Graph Provided
J
P5
K
U
L
P4
N
M
P3
P2
P1
Supply = MPC
T
R
q1 q2
S
q3
Demand = MSB
q4 q5
QUANTITY
1. Micro 3 (c)
Question: Assume that the government imposes
a per-unit tax of (p5-p2) to correct for the
negative externality. [They were told in part
(b) that the negative externality was equal to
(p5-p2).] … Identify the area representing the
deadweight loss.
PRICE
The Graph Provided
J
P5
K
U
L
P4
N
M
P3
P2
P1
Supply = MPC
T
R
q1 q2
S
q3
Demand = MSB
q4 q5
QUANTITY
Deadweight Loss
with Negative Externalities
“Quantity levels less than or greater than the efficient quantity
create efficiency losses (or deadweight losses).”
“Our analysis of the efficiency loss of a tax assumes no negative
externalities …. Where such spillover costs occur, the excise tax
on the producers might actually improve allocative efficiency by
reducing output and thus lessening the negative externality.”
--McConnell, Brue, Flynn, 18e, p. 129 & 368
PRICE
MSC = MPC + Marg. External Cost
J
P5
K
U
L
P4
N
M
P3
P2
P1
Supply = MPC
T
R
q1 q2
Efficient
Quantity
S
q3
Demand = MSB
q4 q5
QUANTITY
PRICE
Deadweight loss
from over
production
MSC = MPC + Marg. External Cost
J
Supply = MPC
P5
P4
P3
P2
P1
Demand = MSB
q1 q2
q3
Market
Quantity
q4
q5 QUANTITY
PRICE
MSC = MPC + Marg. External Cost
No deadweight loss
at efficient quantity.
J
P5
K
U
L
P4
N
M
P3
P2
P1
Supply = MPC
T
R
q1 q2
Efficient
Quantity
S
q3
Demand = MSB
q4 q5
QUANTITY
1. Micro 3 part (c) cont.
Answer: With the tax, the deadweight loss is
zero (0.5 percent answered correctly).