Question

1A) Explain how deadweight loss is generated in an imperfect market?

1B)If the government decides to correct the DWL by focusing on the behavior of the firm, what price should consumers pay for this product?

1C) What is the downside to correcting DWL by focusing on the behavior of the firm?

Answer 1

A deadweight loss is a cost to society because of market inefficiency. Taxes mainly causes Deadweight losses, as they prevent buyers and sellers from realizing some of the gains from trade.

When the govt. imposes a tax on a good, it leads to a fall in output from Q1 to Q2. The gains from trade are not realized by Buyers and Sellers. These lost gains from trade, which create inefficiency in the market, that further creates deadweight loss. As in a market inefficient condition, when good are either overvalued or undervalued, this will certainly affect the welfare of the sellers and cbuyers.

5. If the govt decides to correct the deadweight loss by focussing on the firm, it will eventually reduce the tax and raises a small amount of revenue. This will lead the buyers to pay less and consume more. So the market will face behavorial changes and it will reach at optimum level. If we can consider Marshallian deadweight loss, we can see that, Marshallian deadweight loss is zero when demand is perfectly elastic or supply is perfectly inelastic. The elasticity of supply and demand measures the chang in response by buyers and sellers to the change in price. As greater elasticities of supply and demand will lead to market inefficiency, which will cause greater deadweight loss of a tax.