How to Calculate Deadweight Loss

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Deadweight loss arises when the cost to produce goods or services doesn't provide enough benefit to the buyer and the seller to make it worthwhile to complete a transaction. Knowing how to calculate deadweight loss helps producers decide whether or not to abandon a product line or business model with zero profitability.

What Factors Cause Deadweight Loss?

Most vendors and service providers know that price floors or ceilings, taxes and subsidies cause deadweight loss. Monopolies also cause significant deadweight loss. Corrective measures often cause just as much damage to break-even points and profit margins. Consequently, every business owner needs to know how to use a deadweight loss calculator and graph the possible effects of any loss on the financial stability of their business.

Tips

  • Use the deadweight loss formula:
    Deadweight Loss D = 1/2 (P2 - P1)(Q0 - Q1) where P equals price and Q equals quantity. Q0 equals the quantity of available units before the price ceiling and Q1 equals the quantity available afterward. P2 reflects the seller's price, while P1 reflects the buyer's price.

Deadweight Loss Examples

Calculating deadweight loss provides a snapshot of the effects of state minimum pricing on alcohol and tobacco sales, for example. Landlords and builders must consider the influence of price ceilings, such as rent controls and set-aside percentages, when bidding on construction projects. A deadweight loss graph serves as visual reassurance that paying more than the minimum wage to waitstaff or checkout clerks won't put you out of business.

How Does Deadweight Loss Affect Profitability?

Anything that creates artificial scarcity, such as limited-time offers and loss leaders, pushes the economic equilibrium point up or down. This change affects your ability to supply goods or services while making enough profit to remain in business.

Define Deadweight Loss Berekenen

Amsterdam, in the Netherlands, wields a great deal of influence on worldwide economic policy. The Dutch word "berekenen" means to calculate or reckon. When spoken, the word sounds like the village of Varykino from Doctor Zhivago, not "reckon."

Berekenen also includes the concepts of appraising or evaluating, estimating and drawing up amounts. In short, deadweight loss berekenen means the same thing as calculating a deadweight loss.

When Should I Use a Deadweight Loss Calculator?

Anytime a factor affects available supply versus demand, you need to calculate its current effect on profitability. Say, for example, that you built a skyscraper that towers over its neighbors by 51 floors, including a palatial penthouse. Only those upper 51 floors have spectacular views of the entire city.

Supply for the penthouse equals one unit, while the demand for similar penthouse views includes all 400 of the wealthiest and most influential people in the Social Register. This leaves 399 people demanding spectacular views and only 200 corner units to accomodate this desire.

Set-Asides and Price Ceilings

During negotiations to obtain building permits and occupancy certification, the city demanded that you set aside 25 percent of all units in the building for lower-income housing. The city required you to distribute the rent-controlled units evenly throughout the entire building.

This rent control results in a minimum of 50 corner units commanding an average rent of $500 per month each. The remaining 150 apartments bring you $4,500 per unit, and the penthouse takes in $10,500 per month.

How Do I Create a Deadweight Loss Graph?

Draw a vertical ray labeled "price" and a horizontal ray labeled "quantity," meeting at a 90-degree angle. For ease of calculation, drop the penthouse and set Q0 at 200 to reflect the 200 corner units in the business plan. Set Q1 at 150 to reflect the 50 units that now fall under the price ceiling. Set P2 at 4,500 and P1 at $500. Using the formula Deadweight Loss D = 1/2 (P2 - P1)(Q0 - Q1), calculate Deadweight Loss D.

D= 1/2(4,500 - 500)(200-150)

D= 1/2 (4,000)(50)

D= 1/2 (200,000)

D= $100,000 in lost income to the seller.

References

About the Author

After earning a B.S. Ed. from Kent State University in 1995, Smith provided educational support in multiple Ohio school districts. Smith has managed nine employees and 86 independent adult care providers at a time. In addition, Smith has assisted two charities with successful 501 (C) 3 applications, serving on the board of one for three years. Currently, Smith serves as an independent Avon representative at Avon Beauty by Laura. Her writing chops include one published novel and close to 1500 articles in various online and offline publications.

Photo Credits

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