What is deadweight welfare loss and how is it shown on a market failure diagram?

In Economics, we assume consumers are perfectly rational and make decisions based on maximising their own utility. Welfare, or utility, is a measure of the net benefit derived from the consumption of a good. This is given by the difference between the benefit given by consuming a good minus the cost of consumption. If this is positive then consumption is worthwhile and provides positive welfare. If negative then the cost exceeds the benefit leading to negative welfare. Deadweight welfare loss is the total change is social welfare as a result of an externality. An externality occurs when there is a disassociation between the private cost/benefit of consumption and the social cost/benefit. Social welfare is maximised when social benefit = social cost. Unfortunately, in a free market the market equilibrium is dictated by where private cost = private benefit. Therefore, if there is a difference between social benefit/cost and private benefit/cost (i.e. there is an external benefit/cost) then social welfare isn't maximised. Given this framework, welfare loss is the cumulative difference between social benefit and social cost spanning between the private equilibrium and the socially optimal equilibrium. On an externality diagram there should be two intersections of lines: one is where the private cost and benefits are equal, one is where the social cost and benefits are equal. The welfare loss triangle operates between these two equilibrium and the quantities given. This is because we are showing the change in total welfare between the current equilibrium and the ideal equilibrium. Across this span, social benefit and social cost should differ. The area is the total difference between social cost and social benefit across this span and is triangular. (This is significantly better explained with the presence of a diagram which I will draw).

Answered by Economics tutor

7947 Views

See similar Economics A Level tutors

Related Economics A Level answers

All answers ▸

Describe one effect of an increase in the rate of interest on the economy?


What does Game Theory reveal about a firm's pricing strategy?


What are some Advantages and Disadvantages of Globalisation?


Explain the factors which might determine the natural rate of unemployment (15 marks)


We're here to help

contact us iconContact usWhatsapp logoMessage us on Whatsapptelephone icon+44 (0) 203 773 6020
Facebook logoInstagram logoLinkedIn logo

© MyTutorWeb Ltd 2013–2025

Terms & Conditions|Privacy Policy
Cookie Preferences