deadweight loss

The concept of Deadweight Loss is the concept of mapping the basic economic principle that people respond to incentives. In trade, if the cost of producing an item goes up, forcing an increase in price, the amount bought will decrease (all else constant). Deadweight Loss is a measure of the difference between the economic activity that would have taken place and the economic activity that does take place. For example, pretend the government raised taxes on Doritos by a cent. If people as a whole buy 10 less bags of Doritos due this price increase, the Deadweight Loss is calculated by adding all the consumer surplus and the producer surplus that those 10 bags would have generated. Consumer surplus is the difference between amount that the Consumer was willing to pay and the price the Consumer does pay. Producer surplus is the difference between amount at which the producer was willing to sell and the price at which the producer does sell. On a standard Supply and Demand graph, this is represented as a triangle.

In South Dakota, my economics professor did a case study on the unemployment effects of an increase in the minimum wage (in 2006). He estimated that about 360 individuals in South Dakota would lose their jobs with a Deadweight Loss of $3.84 million to the economy. He presented this to the governor, the bill was still signed into law.

When the price of labor is artificially increased, producers demand less labor. My younger brother, a minimum wage earner, understood this and was livid when the hike was passed into law. He subsequently saw his hours cut and the prices of the things he likes to buy (like pizza) increased. Laws and regulations are not costless.

Besides price ceilings and floors, other government activity causes deadweight loss. Regulations shift costs from producing into complying, artificially increasing the overall cost of production. If producers have to hire lawyers to navigate pages of regulations, that is money that could have gone into useful production. If the producer is paying fines to the EPA, installing carbon filters, or spending time lobbying, this refocuses time, money, and material away from productive uses. This is all deadweight loss. Deadweight loss then, makes everyone poorer. The consumers pay more for goods, buy less of those goods, and consuming less than they otherwise would. Producers pay more to produce goods, sell less than they otherwise would, and divert labor to unproductive uses.

What Deadweight Loss means a real decrease in the standard of living. This is why Detroit is failing . This is why South Korea and West Germany thrived while North Korea and East Germany stagnated.

About christopher fisher

The blog is meant for educational/entertainment purposes. All material can be used and reproduced in any length for any purpose as long as I am cited as the source.
This entry was posted in Econ 101, Economics, Goverment, Price Controls, Taxes. Bookmark the permalink.

2 Responses to deadweight loss

  1. Pingback: understanding the fall of detroit | reality is not optional

  2. Pingback: minimum wage maximum economic ignorance | reality is not optional

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