What is a Deadweight Loss?

Deadweight losses have to do with the difference between gains made by one party, in comparison to losses sustained by a second party, when a particular course of action is taken. The concept of a deadweight loss can be applied to business dealings between individuals, the relationship between a producer and consumers who buy the business’s products, or even the relationship between a government and the citizens residing with the government’s jurisdiction. In all its incarnations, the idea of assessing this type of loss is to determine if the gains achieved are worth the degree of loss that is incurred.

When it comes to business dealings between individuals, a deadweight loss can be something as simple as a landlord increasing the monthly rent, but not making any changes to the amenities associated with the lease. In this scenario, the landlord receives a benefit, in the form of the additional revenue. The tenant sustains a loss, in that no additional services are extended, and it is necessary to reduce spending in other areas of the household budget in order to honor the increased rent payment.

With businesses, the same general approach to a deadweight loss takes place when the company chooses to increase the cost of the items it produces. While the company anticipates increased revenues, consumers are looking at paying more without receiving any additional benefit from the purchases. Assessing deadweight loss in this scenario is very important, since if the increase is enough to alienate a significant number of consumers, revenues will decrease in spite of the price increase per unit sold.

Understanding deadweight loss is also important for governments. For example, a government that is considering a change to current trade restrictions will want to consider the outcome of tightening those restrictions. This means determining if the change will help to increase internal productivity within the nation, or will simply cause a decrease in the standard of living for a significant number of citizens. The answer to those questions can help the government determine if the benefits derived from the action will be sufficient to make the losses incurred by private citizens worthwhile, in terms of improving economic conditions for the majority of the populace.

At its core, assessing the amount of deadweight loss is about making responsible decisions that produce positive outcomes with a minimum of negative impact. Using this concept can often help individuals, businesses, and even governments avoid taking some sort of action that seems a good idea on the surface, but ultimately creates more problems than it solves. When utilized properly, it is possible to avoid situations of net social loss, excess burden on key sectors of the population, and prevent companies in engaging in allocative inefficiency, due to the irresponsible use of limited resources.