1. Deadweight Loss: Sources and Solutions
David A. Anderson Centre College
Chief Reader

3. Where to find this presentation.

4. Deadweight Loss What is it? How do we teach it?
What do the AP questions on DWL look like?

5. Defining Deadweight Loss
“Losses associated with quantities of output that are greater than or less than the efficient level, as can result from market intervention such as taxes, or from externalities such as pollution.”
Krugman’s Economics for AP, p. G-3

6. In the Absence of Externalities
Price
SUPPLY = MSC 25
Consumer Surplus 20 15
Producer Surplus 10 5
DEMAND = MSB
Quantity 53

7. Deadweight Loss of Underproduction
Price
SUPPLY = MSC 25
Deadweight
loss 20 15 10
Parkin and McConnell/Brue/Flynn have similar graphs. 5
DEMAND = MSB
Quantity 53

8. Deadweight Loss Caused by a Tax
SUPPLY with TAX
Price
SUPPLY = MSC
2.50
Per-unit Tax
2.00
1.50
1.00
0.50
DEMAND = MSB
Quantity of Soda 53

9. Deadweight Loss Caused by a Quota
Price
QUOTA Amount
SUPPLY = MSC 25 20 15 10 5
DEMAND = MSB
Quantity of Taxi Rides 53

10. Deadweight Loss Caused by a Price Floor
SUPPLY = MSC
2.50
2.00
Price FLOOR
1.50
1.00
0.50
DEMAND = MSB
Quantity of Milk 53

11. Deadweight Loss Caused by a Price Ceiling
SUPPLY = MSC
2500
2000
1500
1000
Price CEILING
500
DEMAND = MSB
Quantity of Apartments 53

12. Deadweight Loss Caused by a Positive Externality
Price
SUPPLY = MSC 25 20 15 10
Marginal
External
Benefit 5
Marginal Social Benefit
DEMAND
Quantity of Vaccinations 53

13. Deadweight Loss of Overproduction
Price
SUPPLY = MSC 25
Deadweight
loss 20 15 10 5
DEMAND = MSB
Quantity 53

14. The “Arrow” Points to the Socially Optimal Quantity
Price
SUPPLY = MSC 25 20 15 10 5
DEMAND = MSB
Quantity 53

15. Deadweight Loss of Underproduction
Price
SUPPLY = MSC 25 20 15 10
Parkin and McConnell/Brue/Flynn have similar graphs. 5
DEMAND = MSB
Quantity 53

16. The Deadweight Loss of Christmas Joel Waldfogel, American Economic Review, 1993, vol. 83, issue 5, pp
Price
SUPPLY = MSC 25 20 15 10 5
DEMAND = MSB
Fruit Cakes 53

17. Deadweight Loss of Overproduction Due to an Externality
Price
Social Marginal Cost 5
Marginal External Cost 4
SUPPLY 3 2 1
DEMAND
Quantity of Gasoline 53

18. $/unit
Quantity of Cola

19. Demand (additional benefit per unit)
Quantity of Cola

20. (additional cost per unit)
Supply
(additional cost per unit)
Quantity of Cola

21. $/unit
Supply
Demand *
Quantity of Cola

22. True Additional Cost per Unit = Marginal Social Cost
Supply
Demand *
Quantity of Cola

23. Marginal Social Cost Supply Demand $/unit 0 1* 2 3 Quantity of Cola
Pollution makes the 2nd unit cost more than it’s worth.
Demand *
Quantity of Cola

24. Marginal Social Cost Supply Demand $/unit Deadweight loss 0 1* 2 3
Pollution makes the 2nd unit cost more than it’s worth.
Demand *
Quantity of Cola

25. Teaching Net Gains

26. Utility Gains from a Sack Lunch
Time required: minutes
Materials: Each person needs one or more random knick-knack worth about 25 cents (lunch sack optional).

27. How Happy Are You?
With what you brought?

28. How Happy Are You?
With what you brought?
After Trading with Neighbors

29. How Happy Are You?
With what you brought?
After Trading with Neighbors
After Trading with Anyone

30. The Gains from Trade The net gains enjoyed when trade can occur,
And the increases in those net gains when more trade can occur,
Are the types of gains foregone as
DEADWEIGHT LOSS when the amount of trade is reduced by quotas, taxes, price ceilings, and price floors.

31. Teaching Externalities
THE ECOMEDY CLUB
Time required: minutes
Materials required:
2 random books, identical or not
10 knock-knock jokes

32. How to Play
This experiment involves: 2 independent producers of human capital (memorizers) and 2 joint consumers of humor (comedians). The comedians sit on opposite sides of the room, with the memorizers seated roughly in the middle.

33. How to Play First with silence Then with comedy
The memorizers’ goal is to memorize as many consecutive words in a randomly selected sentence as they can in 30 seconds.  
First with silence
Then with comedy

34. Knock Knock!
Who’s there?
Amos.
Amos who?
Amosquito just bit me!
Andy.
Andy who?
Andy bit me again!
House.
House who?
House it going?
Olive.
Olive who?
Olive You!
Sarah.
Sarah who?
Sarah doctor in the house?
Knock Knock!
Who’s there?
Boo.
Boo who?
Stop crying, it’s just a joke!
Goat.
Goat who?
Goat to the door and find out!
Leaf.
Leaf who?
Leaf me alone!
Justin.
Justin who?
Justin time for supper!
Les.
Les who?
Les go for a swim!

35. You will find that there are negative externalities from comedy! 

36. Source
David Anderson and James Chasey, Favorite Ways to Learn Economics 3e, Worth Publishers, 2011.

39. SCORING GUIDELINES
(d) 1 point:
• One point is earned for concluding that, owing to the tax, the market is no longer allocatively efficient AND that total surplus decreases or the tax creates a deadweight loss.

40. 2011 AP Questions

41. 10. Overseas Micro 2 (a)(iii)
Question: Suppose research shows that the more college education individuals receive, the more responsible citizens they become and the less likely they are to commit crimes.
Draw a correctly labeled graph for the education market and show …
(iii) Deadweight loss at the market equilibrium, completely shaded.

42. Deadweight loss from underproduction
PRICE
Deadweight loss from underproduction
Supply = Marginal Social Cost PM
Marginal Social Benefit
Demand = Marg. Private Ben. QM QS
Quantity of Educations

43. 5. Overseas Micro 2 part (b)
Question: Assume that the government imposes an effective (binding) price ceiling on the price of college education.
(ii) Does this price ceiling increase, decrease, or have no impact on the deadweight loss in this industry? Explain.

44. PRICE
Supply = Marginal Social Cost PM
Marginal Social Benefit
Demand = Marg. Private Ben. QM QS
Quantity of Educations

45. PRICE
Supply = Marginal Social Cost P1 PM
PCeiling
Marginal Social Benefit
Demand = Marg. Private Ben. QC QM QS
Quantity of Educations

46. 5. Overseas Micro 2 part (b)
Answer: Deadweight loss will increase because the quantity supplied will decrease.

47. 1. Micro 3 (a)
Question: Draw a correctly labeled graph of the market for good X [known to create a negative externality] and show …
(iv) The area of deadweight loss, shaded completely

48. Deadweight loss from over production
Answer:
Marginal Social Cost
PRICE
Deadweight loss from over production
Marginal Private Cost
Demand = MSB QS QM
QUANTITY
4.1% answered correctly
Market Quantity

49. 2010 AP Question

50. The Graph Provided PRICE J Supply = MPC K U P5 L N P4 M P3 T P2 R S
Demand = MSB P1 q1 q2 q3 q4 q5
QUANTITY

51. 1. Micro 3 (c)
Question: Assume that the government imposes a per-unit tax of (p5-p2) to correct for the negative externality. [They were told in part (b) that the negative externality was equal to (p5-p2).] … Identify the area representing the deadweight loss.

52. The Graph Provided PRICE J Supply = MPC K U P5 L N P4 M P3 T P2 R S
Demand = MSB P1 q1 q2 q3 q4 q5
QUANTITY

53. Deadweight Loss with Negative Externalities
“Quantity levels less than or greater than the efficient quantity create efficiency losses (or deadweight losses).”
“Our analysis of the efficiency loss of a tax assumes no negative externalities …. Where such spillover costs occur, the excise tax on the producers might actually improve allocative efficiency by reducing output and thus lessening the negative externality.”
--McConnell, Brue, Flynn, 18e, p. 129 & 368

54. MSC = MPC + Marg. External Cost PRICEJ
Supply = MPC K U P5 L N P4 M P3 T P2 R S
Demand = MSB P1 q1 q2 q3 q4 q5
QUANTITY
Efficient Quantity

55. Deadweight loss from over production
MSC = MPC + Marg. External Cost
PRICE
Deadweight loss from over production J
Supply = MPC P5 P4 P3 P2
Demand = MSB P1 q1 q2 q3 q4 q5
QUANTITY
Market Quantity

56. MSC = MPC + Marg. External Cost PRICEJ
No deadweight loss at efficient quantity.
Supply = MPC K U P5 L N P4 M P3 T P2 R S
Demand = MSB P1 q1 q2 q3 q4 q5
QUANTITY
Efficient Quantity

57. 1. Micro 3 part (c) cont.
Answer: With the tax, the deadweight loss is zero (0.5 percent answered correctly).