How To Calculate Deadweight Loss

Deadweight loss does not mean a person that is unable to stand. It is actually a term used in economics.  The term is used when there is a difference between a seller and a buyer in terms of price that is affected by the induction of taxes into the equation.  The difference found in the price is called deadweight loss.  To effectively calculate deadweight loss, here are some pointers that you can follow.

  • It's the tax.  Deadweight loss normally occurs when the tax for a certain sale made in the market comes into play thus, screwing with the whole balance of things.  The tax here is a way to create a stream of revenue that the government can take advantage of so it is hardly a valid reason for complaint.  So, to understand what deadweight loss is, it is the difference between the non-taxed price enjoyed by the sellers and the post-taxed price paid by the buyer for any given product or commodity.
  • It is a waste.  The balance is gone when taxes come into play during a transaction in the market.  Remember, the seller is not affect by the tax while the buyer is and in an economist's perspective, the difference created by this is a loss and only ruins the equilibrium of the ideal economy.  In other words, it is deadweight.
  • Visualize it.  If you want to represent the whole occurrence through a graph, picture two curves.  One is the supply and one is the demand.  At a certain price and time, these two curves will meet forming what economists call "the equilibrium" or a meeting of the minds.  Regardless of what you call it, when the tax is integrated, you will notice that the curves will then proceed in slightly different directions instead of continuing on the same path hence, forming a triangle.  The pinnacle of this triangle represents the tax loss.  That difference within the triangle is the deadweight loss.
  • Compute it.  To simplify the concept, calculating the deadweight loss through a computer store.  Let's assume that the computer store's sales have dropped significantly by 10,000 computers each month.  In this case, let's also assume that the tax loss on each computer is $50.  To plot it on the graph, the drop in sales will form the base of the graphical triangle while the tax loss will be the pinnacle of the triangle.  The deadweight loss will now be the area between the pinnacle and the base.
  • Use an equation.  The proper equation to calculate the area of the triangle is quite simple.  Deadweight loss is equal to the price change multiplied by the demanded quantity change.  The result should then be multiplied by the variable .5.  Therefore, if the price of the computer increases by $50 due to the tax and the demand drops by 10,000, then your computation should look like this:  DL= (50X10,000)(.5).

Based on the equation you worked on and the example given, the deadweight loss should be at $250,000.  The area of the triangle in the graph will represent this amount.


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