Deadweight Loss

Deadweight loss is an economic term that describes the loss incurred by society due to market inefficiency when demand and supply does not organically meet at an equilibrium.

There are various reasons for deadweight loss to occur and accumulate.

It is almost impossible to totally eliminate it from economies, and therefore, remains a theoretical concept.

Some of the causes of deadweight loss can include:

  • Misallocation of resources
  • Price controls
  • Wage controls
  • etc

These can lead to loss to society.

Effects of deadweight loss

One of the most glaring impact of inefficient markets is that products and services can be underpriced or overpriced.

When a product or service is overpriced, consumers would purchase less of it as it can adversely affect the household budget of the average family.

For those willing to purchase something that is overpriced, it affects their buyer power in purchasing other products and services which they would have otherwise spend their money on.

As consumers avoid buying a product due to an over-valuation, it can lead to a lower sell-through leading to a company carrying more inventory than it has to.

This only leads to more market inefficiencies.

When a product or service is underpriced, consumers might benefit from the cheaper merchandise they can purchase with their money.

But this have a negative impact on businesses as they might find it harder and harder to generate enough revenue to cover their overhead costs.

If this inefficiency is prolonged, a company could very well face a total collapse of their business.

Setting a national minimum wage can sound advantageous to low-skilled workers. But it can also have a reverse effect on the job market as a whole and increase deadweight loss.

This is because employers might have to overpay for staff that are unskilled or only choose to hire people who have enough qualifications to meet the minimum wage levels. Thus, leaving unqualified jobseekers with no jobs.

This can actually lead to massive unemployment.

For example, if the minimum wage is set at $1,200, then employers might only want to hire people with resumes that contain qualifications and expertise that they deem would be worth $1,200. This can result in anyone not meeting educational criteria out of work.

Society as a whole would pay a national price for such wage control measure when they are unnecessary.

Price ceiling is another example cause of deadweight loss.

If the price of a product is set at a limit, producers and innovators might simply refuse to conduct research and development to improve their offerings as no matter how great their products are, the law would not allow them to charge what the products are really worth.

Companies might only make a small profit margin that is unsustainable or have to make a loss with every sale.

This also means that the ability and capacity of businesses would not be able to operate at their full potential to serve society and the economy.

In fact, if a price ceiling is suddenly introduced into a market, companies might have to cut jobs in view of the lower margins and profits projected.

With all these in mind and we have barely scratched the surface, deadweight loss is something that governments constantly try to reduce or prevent when conceptualizing national policies.

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