What Is the Calculation for Deadweight Loss?
Deadweight loss is an economic term which means inefficiency or a deficiency as a result of an inefficient allocation of resources. In other words, deadweight loss refers to the costs that society suffers as a result of an inefficiency in the market. Examples of deadweight loss include a loss in production revenue as a result of inaccurate economic forecasting.
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The Facts
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The primary calculation of deadweight loss in economics is the one that applies to the sales tax. Sales tax creates a source of revenue for the government when goods are exchanged in the marketplace. It comes from a difference between the pre-tax price received by producers and the after-tax price paid by the consumers on a particular product, according to econmodel.com.
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Graphical Representation
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On a graph, the supply curve line slants down from left to right and the demand curve line slants up from left to right. The place where the two lines intersect is called the equilibrium (or in our case, the no-tax equilibrium). When the sales tax is added, there is a cut off in price, somewhere prior to the no tax equilibrium point. As a result, a triangle forms, on the graph, between the after tax price point and the no tax equilibrium point. This triangle is called the deadweight loss.
Features
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Tax on a product is an economic inefficiency or deadweight loss, according to "Deadweight Loss" at college-cram.com. The tax does not affect the price at which the seller sells the product but does raise the price to the buyer. As a result, the supply and demand curves no longer meet at a point of efficiency (or equilibrium) but at some point earlier. In order to calculate deadweight loss, the supply and demand curves as well as the amount of the tax need to be known.
Calculation
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For example, suppose we are given (or have previously calculated) that sales at a truck dealership dropped by 50,000 trucks per month and the tax revenue loss is $100 per truck (in other words, $100 per truck is not sold by the dealership). On the graph, the sales drop is represented as the base of the triangle and the tax revenue loss is represented as the height of the triangle. The calculation of deadweight loss is the area of the triangle.
Area of Triangle
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An area of a triangle is found by the formula A = (1/2) x B x H, where A is area of the triangle, B is base of the triangle, and H is height of the triangle. Therefore, deadweight loss can be found by the formula Deadweight Loss Area = (1/2) x B x H. Using the example above, the base of the triangle is 50,000 and height of the triangle is $100. Therefore, Deadweight Loss = (1/2) x 50,000 x 100 = $2,500,000.
References
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