What is deadweight loss?

Deadweight loss refers to the loss of economic efficiency that occurs when equilibrium for a good or service is not achieved or is not achievable. This usually happens due to market distortions, such as taxes or subsidies, which prevent the market from reaching its optimal output level. When these distortions are present, they can lead to a decrease in total surplus, which is the sum of consumer and producer surplus.

When a tax is imposed, for example, the price consumers pay increases while the price received by producers decreases, leading to a decrease in the quantity traded in the market. Consequently, the total surplus available in the economy is not maximized because both consumers and producers are affected by the change in their behaviors due to the tax.

This concept helps in understanding how interventions in the market can lead to inefficiencies that ultimately hurt both consumers and producers, resulting in a loss of potential economic welfare that could have been realized in a tax-free or unregulated market.