Deadweight Loss in Economics - Essay Example

Industry Economics Deadweight loss is the loss that is incurred due to the loss of monetary efficiency that occurs when the equilibrium of goods or services has not reached Pareto optimality. It can also be said to occur when customers having more marginal benefits than costs do not purchase a product whereas the customers who incur more marginal costs than their marginal benefits are purchasing the goods (Cowling & Waterson, 2003). Deadweights can occur and become severe due to the presence of monopolistic pricing where there exist artificial scarcities, subsidies, and taxes or where there are price ceilings and floors that are binding on the parties trading (Muller, 2012).

Drawing from the contributions of Cowling along with Muller economists should be greatly concerned because the two suggested that the estimates made on deadweight losses are usually sensitive to the assumptions made concerning the elasticities of demand. The two made further adjustments to Hamburger’s methodology which suggested that deadweight losses are measured by determining the differences that exist between the rates of return for a certain industry with the average rates of return that have been gotten for all the other similar industries (Cowling & Waterson, 2003).

The adjustments suggested that the prices charged on the elasticities are equal to one. The two additionally stated that a company’s maximizing price for profit is equal to the price elasticities of demand. According to Cowling along with Muller, the industry’s deadweight loss equals half the monetary profits for all firms in an industry (2003). The conditions that are necessary for deadweight to become severe include environments where there exists monopoly pricing along with the presence of artificial scarcities.

Monopolies usually set their prices without any regard for the strategies that are being used by their competitors. This will normally make the consumers go for the available substitute goods which may not be available thereby causing the marginal cost of a commodity to rise. When compared to the marginal benefits being reaped from using the products, the products can be said to experience a deadweight loss since their costs outweigh their benefits. When the demand for a product is more elastic, the monopoly in an industry tends to lower prices so that more of its products are sold (Cowling & Waterson, 2003).

The monopolist within a certain industry thus tends to set the prices and demand their products when their demands are elastic. This is because the price set by a monopolistic trader can be termed as a function that does not decrease in relation to the marginal costs incurred. Welfare losses do not occur do not reduce monotonically when demand is more elastic even if the monopolist profits increase. This happens because changes in quantity are usually small when a product’s demand is inelastic which in turn narrows the width of the deadweight loss triangle (Muller, 2012).

Another condition that makes the deadweight in the industry to become severe is the presence of taxes along with subsidies. According to the Harberger formula for calculating deadweight losses, increases in taxation happen when demand for a product is more elastic. This only happens in a market where there is competition and the tax charges are given to all the participants within this market. In monopoly markets where taxes are accounted for the monopolist's profits vary according to the elasticity levels being experienced by their products.

Taxes usually assist in the redistribution of money from the rich people to the poor who usually benefit more from their use. When an excessive burden through taxation is placed on the people, society greatly suffers due to the high prices that are charged for the products on sale as a result of the high marginal costs that their production incurs. This may make the products unaffordable to most consumers due to the high prices that are charged (Cowling & Waterson, 2003). The final factor that influences deadweights is the price ceilings along with floors that are established for products that are on sale.

The price ceiling refers to the maximum permitted price levels in an economic transaction. The price ceilings are used by various regulatory bodies in maintaining the prices, rates of interest, charges, and debts below certain specified levels. They are used for the purpose of enabling individuals who do not earn high incomes to purchase vital resources that are beyond their reach. According to economists, these prices do not however have an effect on the equilibrium prices especially if the product price goes below the ceiling level (Cowling & Waterson, 2003).

A deadweight loss is established when the price ceilings are set below the equilibrium prices. The price floor, on the other hand, refers to the lowest limit that is agreed upon by the trading parties or the government in a business transaction. Price floors can be created for items such as wages, prices along with interest rates. For instance, the government of a certain country might decide to put up price floors for an alcoholic beverage due to health reasons. The price floors help to reduce the marginal costs though they increase the marginal benefits (Muller, 2012).

Anti-trust policies usually break up organizations so that they can act in a competitive manner. They break up organizations that are monopolies while preventing mergers that would make them augment their power within the market (Cowling & Waterson, 2003). Economically, anti-trusts are usually implemented in order to increase the efficiency of a monopoly in utilizing the resources at its disposal (Muller, 2012).