Wednesday, November 10, 2010

Econ 101: Deadweight Loss

Another island off the shores of Stage One.
Popularizing Deadweight Loss
Let's do the deadweight loss from a tax.

Imagine that you want to go to New York on a trip.  You value the trip at $50 and a bus ticket costs $40.  Do you take the trip? 

A. Yes.  The value ($50) of the trip exceeds the cost of the ticket ($40) so you travel to New York.   

How much consumer surplus (net value) do you get from the trip?

A. $10=$50-$40.

The government taxes bus tickets which raises the price of a bus ticket to $60.  Do you take the trip?

A. No. The value of the trip is now less than the price of the ticket.

What happened to the $10 consumer surplus which you used to get when there was no tax?

A. It's gone since no trip takes place.

Did the government get any tax revenue from you?

A. No.

Key idea: Consumers lose but the government does not gain from trips that are not taken.

Conclusion: Deadweight loss is the value of the trips (trades) which do not happen because of the tax.


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