Deadweight loss measures the loss
A in revenue to the government when buyers choose to buy less of the product because of the tax.
B of total revenue to business firms due to the price wedge caused by the tax.
C of equality in a market due to government intervention.
D in a market to buyers and sellers that is not offset by an increase in government revenue.
The correct answer and explanation is:
The correct answer is: D) in a market to buyers and sellers that is not offset by an increase in government revenue.
Deadweight loss refers to the economic inefficiency that occurs when the total surplus (the sum of consumer surplus and producer surplus) in a market is reduced due to market distortions such as taxes, subsidies, price floors, or price ceilings. When a government imposes a tax on a good or service, it causes the price paid by consumers to rise and the price received by producers to fall. This creates a wedge between the price buyers are willing to pay and the price sellers are willing to accept. As a result, some transactions that would have occurred in a tax-free market no longer take place.
Deadweight loss represents the value of these foregone transactions, which leads to a reduction in total economic welfare. It is the area on a supply and demand graph that represents the lost surplus that neither the government nor the producers or consumers capture. This loss is not compensated by the increase in government revenue because the tax revenue does not fully offset the decrease in the total welfare.
For example, if a tax is imposed on a good, the price paid by consumers increases, leading to a decrease in the quantity of the good bought and sold. This decrease in the quantity of trade results in a loss of economic benefits to both consumers and producers, which is captured by the deadweight loss. The larger the tax or price distortion, the greater the deadweight loss will be, as more mutually beneficial transactions are prevented from occurring.
Therefore, deadweight loss highlights the inefficiency created by taxes or other market interventions, showing how such policies can harm overall economic well-being by preventing mutually beneficial trades.