Question

4. When there is a deadweight loss caused by a tax

a. consumers are better off, but produces are worse off.

b. only inefficient trades are being made.

c. the quantity bought and sold is not affect by the tax.

d. some efficient trades are not being made.

The incorrect choice to this question is

"B. only inefficient trades are being made."

Answer 1

Solution:

Deadweight loss means total social welfare is not being maximized, and is lower than what it would have been at an optimal and efficient market outcome (where it is maximized). Whenever there is taxation or such binding government interference, the total welfare reduces as:

1. Consumer surplus is lower than before

2. Producer surplus is lower than before

3. Even though tax revenue (to the government) component is added for social welfare, due to reduced quantity traded under taxation, this is not enough to cover the total social welfare lost.

Thus, we can eliminate options (a) and (c) straightaway.

Depending on the taxation, amount of deadweight loss incurred might differ (lower for some strategies, hiigher for other taxation strategies), but inefficiency always occurs.

Thus, the correct option is (B) only inefficient trades are being made.