Allocative efficiency and deadweight loss

The definition you must be able to write

The standard gives it to you word for word, and examiners expect it back:

• Allocative efficiency occurs when the sum of consumer surplus and producer surplus is maximised — that is, when total surplus is as large as it can be.

• Deadweight loss indicates a market is allocatively inefficient.

• A second, equivalent way to say it, and the one the Assessment Reports quote: allocative efficiency occurs where D = S.

  • At that point the value of the last unit to a consumer exactly equals the cost of producing it.
  • Resources are allocated to producing exactly the goods society values most.

What deadweight loss is

• Deadweight loss (DWL) is the loss of total surplus caused by the market not trading at Qe.
• It is surplus that nobody gets — not consumers, not producers, not the government.
  • This is the point students miss. A tax transfers surplus to the government; the DWL is the part that is destroyed, not moved.
• On the model, DWL is the triangle between the demand curve and the supply curve, over the units that are no longer traded.

Where a deadweight loss comes from

• Any change that pushes the traded quantity away from Qe creates a DWL:

Change	Quantity moves	Why surplus is lost
Indirect tax	Below Qe	Units worth more than they cost are no longer made
Subsidy	Above Qe	Units costing more than they are worth are now made
Maximum price	Below Qe	Producers withdraw units consumers valued
Minimum price	Below Qe	Consumers withdraw from units producers could supply
Quota	Below Qe	Trades that would have created surplus are banned
Tariff	Below the free-trade quantity	Two triangles — see the tariff page

• Notice that a subsidy creates a DWL too, even though it makes both CS and PS bigger. The subsidy costs the government more than the extra surplus it creates.

How to identify the DWL triangle on any diagram

Three questions, in order:

1. What quantity is actually traded now? Call it Q₁.
2. Where is the free market Qe? The DWL sits between Q₁ and Qe.
3. What are the two boundaries? The demand curve above and the supply curve below across that range.

• The triangle always has its point at the free market equilibrium — that is the tell.

Saying it in a way that scores

• Achieved: "There is a deadweight loss, so the market is allocatively inefficient."
• Merit: "A deadweight loss of area XYZ appears between Q₁ and Qe. Total surplus has fallen, so the market is no longer allocatively efficient."
• Excellence: "Consumer surplus falls by A + B, producer surplus falls by C + D, and the government gains A + C. The remaining areas B + D are gained by nobody — that is the deadweight loss, and it is the proof that total surplus is no longer maximised, so the market is allocatively inefficient."