Question

Explain in your own words why imposing a subsidy creates a deadweight loss.

Answer 1

Due to the imposition of a subsidy, the price paid by buyers falls and the price recived by sellers increase and the quantity transacted in the market also increases. Now, the cost that the government has to bear by providing the subsidy which is equal to the new quantity transacted multiplied by the per unit subsidy becomes higher than the increase in benefits received by consumers and producers which is is reflected by increase in total surplus. Hence there is a lost surplus or welfare loss due to imposition of this subsidy which is known as the deadweight loss.