Which of the following would likely cause the greatest deadweight loss in a competitive market?

• A. A price ceiling set far below the equilibrium price
• B. A price floor set slightly above the equilibrium price
• C. A price ceiling set at the equilibrium price
• D. No government intervention in the market

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of deadweight loss (DWL). Deadweight loss occurs when market interventions prevent the market from reaching equilibrium, causing a loss of total surplus (consumer plus producer surplus). It represents inefficiency in the market.
2. Step 2: Recall that a price ceiling is a legal maximum price, and a price floor is a legal minimum price. Both can cause deadweight loss if they prevent the market price from reaching equilibrium.
3. Step 3: Analyze the effect of a price ceiling set far below the equilibrium price. This creates a significant shortage because the quantity demanded exceeds the quantity supplied at that low price, leading to a large deadweight loss.
4. Step 4: Compare this to a price floor set slightly above equilibrium. This causes a surplus, but since it is only slightly above equilibrium, the deadweight loss is smaller than a price ceiling set far below equilibrium.
5. Step 5: Recognize that a price ceiling set exactly at equilibrium or no government intervention causes no deadweight loss because the market clears efficiently at equilibrium price and quantity.