In a market, both consumers and producers benefit, creating economic welfare. Buyers gain from economic trades as they value the product they are purchasing higher than the price they pay for it: this benefit is known as consumer surplus. Sellers gain from trades as the cost of production is less than the price that the product is sold for: this benefit is known as producer surplus. Total market welfare is calculated by adding the total consumer surplus and producer surplus together.
As shown in the model above. The shaded areas show the consumer and producer surplus locations and the red circle at the equilibrium shows the point where surplus is maximised for both parties.
Deadweight loss shows inefficiencies within a market and can result in market failure. It shows the difference between the level of welfare present in the market and the maximum welfare possible.
As shown by the model above, deadweight loss occurs when the market is not functioning at the equilibrium point. This can mean prices are too high or too low, there is an over or under-production of a product or resources are not being allocated efficiently.
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