Consider a supply and demand graph where a binding price floor is set above the equilibrium price. What does the deadweight loss associated with the price floor represent?

• A. The area between the supply and demand curves below the equilibrium price
• B. The reduction in total surplus caused by trades that no longer occur due to the price floor
• C. The increase in producer surplus resulting from the higher price
• D. The loss in consumer surplus that is fully transferred to producers

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the concept of a price floor. A price floor is a legally imposed minimum price set above the equilibrium price, which prevents the market price from falling to the equilibrium level.
2. Step 2: Recognize that when a binding price floor is set above equilibrium, it causes a surplus because the quantity supplied exceeds the quantity demanded at that higher price.
3. Step 3: Identify that deadweight loss (DWL) represents the loss of total surplus (the sum of consumer and producer surplus) due to trades that no longer occur because the price floor prevents the market from clearing.
4. Step 4: Visualize the deadweight loss on the supply and demand graph as the area between the supply and demand curves over the range of quantities that are no longer traded because of the price floor.
5. Step 5: Conclude that the deadweight loss is not simply a transfer of surplus from consumers to producers, nor is it the increase in producer surplus alone; rather, it is the net loss in total surplus caused by the reduction in mutually beneficial trades.