What is deadweight loss, and how do you calculate it?

In this blog post, we’ll answer those questions and give you a few examples of how to apply the concept.

Deadweight loss is an important economic concept that measures the efficiency of a market. It can help you understand when a market is functioning well or not.

Let’s get started!

Table of Contents

## How To Calculate Deadweight Loss

## What is Deadweight Loss?

A deadweight loss is a cost to society created by market inefficiency, which occurs when supply and demand are out of equilibrium.

Mainly used in economics, deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources.

Price ceilings, such as price controls and rent controls; price floors, such as minimum wage and living wage laws; and taxation can all potentially create deadweight losses.

With a reduced level of trade, the allocation of resources in a society may also become inefficient.

## Deadweight Loss Formula

Here is the formula to calculate deadweight loss:

`Deadweight Loss = ½ * Price Difference * Quantity Difference`

Below you will find some step-by-step instructions to calculate deadweight loss as well as some other useful resources:

## Calculating Deadweight Loss

To calculate deadweight loss, you’ll need to know the change in price and the change in the quantity of a product or service.

Use the following formula:

`deadweight loss = ((Pn − Po) × (Qo − Qn)) / 2`

Where:

**Po**= the product’s original price**Pn**= the product’s new price after taxes, price ceiling and/or price floor is accounted for**Qo**= the product’s quantity that was originally requested**Qn**= the product’s quantity that was requested after taxes, price ceiling and/or price floor is introduced

Use the following steps to calculate deadweight loss:

- Determine the original price of the product or service.
- Determine the new price of the product or service.
- Find out the product’s originally requested quantity.
- Find out the product’s new quantity.
- Calculate the deadweight loss.

## Examples of Deadweight Loss Calculations

Let’s take a look at some examples:

### Deadweight Loss Formula Example #1

Imagine that you want to go on a trip to Vancouver. A bus ticket to Vancouver costs $20, and you value the trip at $35. In this situation, the value of the trip ($35) exceeds the cost ($20) and you would, therefore, take this trip. The net value that you get from this trip is $35 – $20 (benefit – cost) = $15.

Before buying a bus ticket to Vancouver, the government suddenly decides to impose a 100% tax on bus tickets. Therefore, this would drive the price of bus tickets from $20 to $40. Now, the cost exceeds the benefit; you are paying $40 for a bus ticket, from which you only derive $35 of value.

In such a scenario, the trip would not happen, and the government would not receive any tax revenue from you. The deadweight loss is the value of the trips to Vancouver that do not happen because of the tax imposed by the government.

### Deadweight Loss Formula Example #2

When goods are oversupplied, there is an economic loss. For example, a baker may make 100 loaves of bread but only sells 80. The 20 remaining loaves will go dry and moldy and will have to be thrown away – resulting in a deadweight loss.

When goods are undersupplied, the economic loss is as a result of demand going unfulfilled. If we take the baker example again – the baker makes 100 loaves of bread and sells them all. However, there are 20 customers who still want bread. This is a deadweight loss because the customer is willing and able to make an economic exchange, but is prevented from doing so because there is no supply.

### Deadweight Loss Formula Example #3

You need to take a round-trip train ride from New York to Washington D.C. In the past, you’ve paid $150 for this train ticket, which is how much you value the trip. When you check the prices, this same ticket is $130 dollars, making the total added value of this trip $20 dollars.

The next day, regulations change and the government is imposing a new tax of 50 percent on all public ground transportation. This means that your ticket now costs $195 instead of $130, erasing the previously added value. You decide not to buy the ticket because of the new price, meaning a missed opportunity for you and an economic loss for the train company.

## Summary

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