Question

how do you calculate welfare loss/gain?

Answer 1

There are 4 possible situations that give rise to welfare loss/gain.

Consumer surplus (CS) = Area between demand curve and market price

Producer surplus (PS) = Area between supply curve and market price

(Situation 1 - Monopoly)

A monopolist maximizes profit by equating MR and MC. Since efficiency is maximized when Price equals MC, and Price > MR, it means that Price > MC. Therefore, monopoly produces lower output at higher price compared to efficient outcome.

Deadweight loss = (CS in efficient outcome + PS in efficient outcome) - (CS in monopoly + PS in monopoly)

(Situation 2 - Price floor or Price ceiling)

A binding price floor is imposed higher than equilibrium price, which decreases quantity demanded and increases quantity supplied, causing a surplus and creating a deadweight loss.

Deadweight loss = (CS in free market + PS in free market) - (CS with floor price + PS with floor price)

A binding price ceiling is imposed lower than equilibrium price, which increases quantity demanded and decreases quantity supplied, causing a shortage and creating a deadweight loss.

Deadweight loss = (CS in free market + PS in free market) - (CS with ceiling price + PS with ceiling price)

(Situation 3 - Taxes, including Import Tariff)

A tax (or import tariff) increases effective market price, lowers market quantity, decreases CS, decreases PS and creates a tax revenue for government.

Deadweight loss = (CS in free market + PS in free market) - (CS with tax + PS with tax - Tax revenue)

(Situation 4 - Subsidy)

A subsidy decreases effective market price, increases market quantity, increases CS, increases PS and creates a cost of subsidy for government.

Deadweight loss = (CS in free market + PS in free market) - (CS with subsidy + PS with subsidy + Cost of subsidy)