What is deadweight loss?

• A. The net lost welfare due to underproduction or overproduction relative to efficient allocation
• B. The total amount of tax revenue
• C. The sum of consumer and producer surplus
• D. The government's budget deficit

Answer: (A)

Deadweight loss is the net welfare loss that occurs when quantity is not at the efficient level. In a free, undistorted market, total social welfare (the sum of what consumers value the good and what producers incur as costs) is maximized where marginal benefit equals marginal cost. When a distortion—like a tax, subsidy, or price control—pushes the market to produce too little or too much, some mutually beneficial trades don’t happen (or happen in ways that aren’t as valuable). The result is a loss of welfare compared with the efficient allocation, shown as a triangular area on the supply–demand diagram. This loss reflects reduced consumer and producer surplus that isn’t offset by any government revenue or other gains. It’s not the tax revenue (that’s a transfer), and it’s not simply the total surplus with no distortion. It is the extra decrease in welfare from producing at an inefficient quantity.