What is deadweight loss?

• A. DWL is the total surplus under perfect competition.
• B. DWL is the gain from trade due to specialization.
• C. DWL is the loss of total surplus due to market inefficiency; externalities or taxes.
• D. DWL is the increase in government revenue.

Answer: (C)

Deadweight loss is the loss of total surplus that occurs when a market operates inefficiently because of distortions like taxes, subsidies, price controls, or externalities. When such distortions push the quantity traded away from the socially optimal level, some potential gains from trade aren’t realized, so the combined satisfaction of consumers and producers falls by more than any government revenue or subsidies can compensate for. A tax, for example, reduces trades and creates a triangular area on the welfare graph that represents this lost surplus, even though the government may collect tax revenue. It’s not the total surplus itself, not the gains from trade due to specialization, and not the government revenue—the DWL is specifically the reduction in welfare from the inefficient quantity.