Deadweight Loss (D.L.) is calculated as follows: D.L. = 0.5 {(p2p1)*(q2q1). Where: (p2p1) is the change in price after tax has been imposed. (q2q1) is the change in demand.
Deadweight loss arises when there is a difference in the quantity on demand when the market is at equilibrium (when the market is operating at its most efficient level), and when the market prices are determined based on the taxes imposed in the trading environment. This means that the economy is not at its most stable position.
The following are important steps that are crucial in the determination of deadweight loss:
1) Graphically come up with both the supply and demand curves.
2) Establish the quantity and price when the market is at its equilibrium.
3) Calculate the resulting quantity on demand and the corresponding price after the introduction of inefficiencies in the market (may be in the form of taxes).
4) Using the obtained values of the changes in demanded quantity and price, apply the formula, D.L.=0.5{(q2q1)*(p2p1)}, to get the deadweight loss.
NOTE:
A change in price and quantity of demand look almost like height and base of a triangle. Remember that the formula of getting the area of a triangle is 0.5*base*height. This analogy of a triangle is a perfect relationship with deadweight, from the supply and demand curves drawn.
1. Draw the supply and demand curves. 2. Calculate price and quantity demanded at market efficiency. 3. Keeping supply constant, calculate the new quantity demanded and price after
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