Question

5) Consider a situation where the market equilibrium would result in 200 units of some good

being produced (that is – at Q = 200 units is where the supply and demand curves intersect.)

a) Explain why a deadweight loss would arise if production were to stop at only 150 units

being produced.

b.)Explain why a deadweight loss would arise if production were to total 250 units.

Answer 1

A deadweight loss arises because of lost output generation and market inefficiency where the society incurs a cost in terms of increase in prices and reduction in access to quantity made available when market demand doesn't match market supply.

a) If production were to stop at only 150 units, demand would be greater than supply, where demand is 200 units and supply is only 150 units. Thus because of this 50 units are not consumed and the 150 units which consumers do buy are at a higher price as demand exceeds supply. Thus it leads to a deadweight loss where 50 units are neither produced and nor consumed.

b) If production were to total 250 units, quantity supplied would be 250 units, while the quantity demanded would be 200 units. Supply will exceed demand. The price reduces from the efficient market value leading to a deadweight loss to the producer as the price charged by it and thus the earnings reduce, where additional 50 units of quantity is supplied which has no demand in the market equilibrium. The deadweight loss is the reduction in price of the good and the increase in quantity which is not demanded. It is caused due to excess production of goods in the market which reduces efficiency and increases cost to the economy, in terms of reduced value for goods.