How does the concept of deadweight loss apply to a per unit tax imposed on a good in a competitive market?

• A. Deadweight loss is the total amount of tax revenue collected by the government from the per unit tax.
• B. Deadweight loss represents the reduction in total surplus that occurs because the tax prevents some mutually beneficial trades between buyers and sellers.
• C. Deadweight loss is the increase in consumer and producer surplus resulting from the tax.
• D. Deadweight loss only occurs if the tax is paid entirely by producers and not by consumers.

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the concept of deadweight loss (DWL). DWL refers to the loss of total surplus (the sum of consumer and producer surplus) that occurs when a market is not operating at its efficient equilibrium, often due to external interventions like taxes.
2. Step 2: Recognize that a per unit tax imposed on a good increases the price buyers pay and decreases the price sellers receive, creating a wedge between supply and demand prices.
3. Step 3: Identify that this price wedge reduces the quantity traded below the efficient market equilibrium quantity, meaning some trades that would have benefited both buyers and sellers no longer occur.
4. Step 4: Understand that the deadweight loss is the value of these lost trades — the reduction in total surplus — and it is not equal to the total tax revenue collected by the government.
5. Step 5: Conclude that deadweight loss arises because the tax distorts market behavior, preventing mutually beneficial exchanges, and it occurs regardless of whether the tax burden falls more on consumers or producers.