Thank you for using College-Cram.com and thank you for your excellent question about deadweight loss.

Deadweight loss is an economic inefficiency - in this case introduced by a tax on a product. The tax raises the price to the buyer but not for the seller, resulting in equilibrium for supply and demand moving from the point of efficiency. To calculate the deadweight loss we need to know the supply and demand curves (so we can calculate the quantity demanded at market efficiency and with the tax imposed) and the amount of the tax. You provided us with all this information, so let's begin.

Original Demand Quantity: The Demand curve you provided tells us that before the tax is imposed the quantity demanded at a price of $10,000 is 2 (million cars per month). How did I get that? Here goes:

The formula you gave us for the demand curve is
10,000 = 15,000 - 2,500Q
which reads, at a price of $10,000 the quantity demanded is calculated from a formula of 15,000 minus 2,500 times the quantity demanded. To solve, we add 2,500Q to both sides and subtract 10,000 from both sides - this part is algebra, not economics, giving us:
2,500Q = 15,000 - 10,000, or
2,500Q = 5,000
Now, we divide both sides by 2,500 to isolate Q
Q = 5,000/2,500 = 2

That is the 2 million car demand I referred to at the beginning.

New Demand Quantity: To calculate the deadweight loss from adding $100 tax we start by calculating the amount of cars that will NOT be sold due to the increase in price. We use the same demand curve you provided, but at the new price of 10,100:

10,100 = 15,000 - 2,500Q, or
Q = 4,900/2,500, or
Q = 1.96

We were selling 2,000,000 cars per month, but now will only sell 1,960,000 cars per month.

Deadweight Loss: Sales drop by 40,000 cars per month, which is represented on the graph below as the base of the yellow triangle. The tax revenue loss of $100 per car NOT sold is represented as the height of the yellow triangle. The calculated deadweight loss in this case is the area of the yellow triangle, or 1/2 x base x height: 

• deadweight loss = 1/2 x base x height; or
• deadweight loss = 1/2 x 40,000 x $100, or
• deadweight loss = $2,000,000
  

Normally supply is NOT a constant and there is also deadweight loss below the horizontal line to reach down to the supply curve - not in your example. I think we're done. Here is what the graph looks like:

I hope this helps. Let us know if you need anything else.

Thanks for your question, Emilie. There is not one single answer for these questions. There are justifications for numerous positions and perspectives. With an understanding of the inter-relationship of these goals, though, we can see the effect of making one primary over another. For example:

From the Micro-economic viewpoint, the goals of efficiency and equity are generally regarded as most important. (The other three are most important to a Macro-economic viewpoint.) Of the two, it is debatable which is of more importance.

Equity calls for a fair distribution of wealth and income in a society, although what constitutes "fair" is not easily identified. (Is it purely socialist in that everyone shares equally in all, or is it more a question of everyone getting just what they need?) As a primary goal, equity would most impact freedom, since freedom would entail a person's ability to improve their economic standing.

Efficiency is defined as the greatest amount of satisfaction from the available resources. This concept is difficult to identify in practice -- you cannot point to an economic model and be able to say with certainty that it displays maximum efficiency. Efficiency is also most impacting on freedom, since by definition it represents the best (and only) uses of available resources and so limits individual freedoms.

Professor Cram

Thanks for your question, Denise.

The answer is not as simple as it used to be. For many years the popular theory has been there is a tradeoff between inflation and unemployment.

Inflation is basically too much money chasing too few goods, so prices continually escalate. The popular theory has been that the money supply impacts economic growth and easier money (lower interest rates) stimulates the economy, and increases employment (thereby lowering unemployment). Tighter fiscal policy restricts the economy, reducing employment and increasing unemployment. This monetarist policy has guided the Federal Reserve in trying to navigate the knife edge of economic growth without inflation for the past several decades.

Recent studies dispute the tradeoff effect in the long run, but allow for short-term impact of tightening and easing money supplies. This has brought about renewed calls for returning to the gold standard which would virtually eliminate inflation and eliminate the monetarist approach to economic governence. How then to avoid the cycles of economic growth and recession? It seems that the more we know the more we don't know.

I hope this helps. Let us know if you need anything else.