Deadweight Loss also known as excess burden or allocative inefficiency)
Market equilibrium pricing: Why is it the best?
It is so because this is the only price equilibrium which maximizes both the consumer and producer surplus.
From the diagram we see that the market equilibrium price is P*, and the equilibrium quantity is Q*.
Here the quantity demanded is equal to the quantity supplied.
Here the consumer surplus is ABC, and the producer surplus is BCD.
The total surplus is ACD.
At any other price but this market equilibrium P*, there will be either overproduction or under production.
This will lead to a loss in consumer and producer surplus.
At any other quantity of output, other than the market equilibrium of Q*, there will be a dead weight loss.
Dead weight loss in under production:
If production is OQ1, price will be OP1, at which point the quantity demanded will be OQ1.
At P1, the consumers still enjoy a consumer surplus of ADP1amount.
They lose ADC amount of consumer surplus, because if price were P*, they would have bought quantity OQ*, thus enjoying the ADC amount of consumer surplus also.
On the other hand at price P1, the producers enjoy a producer surplus of P2BE, but if price were P* they could have enjoyed the extra producer surplus of BCD.
Thus the combined consumer and producer surplus of ADC and BCD respectively is lost at price P1.
Thus the total loss of surplus is ABC, which is called a dead weight loss.
The highest producers plus consumers surplus is enjoyed where the demand is equal to supply and so marginal benefit = marginal cost.
Dead weight loss in over production:
If there is over production, OQ1, then again there will be a total dead weight loss of consumer and producer surplus combined of ABC.
