Question

How does the extent to which there is competition in the market affect the size of the deadweight loss caused by a tax imposed on producers? Explain by comparing the deadweight loss from taxation in competitive and monopolistic markets.

Answer 1

Deadweight Loss & Imposition of Tax
A deadweight loss refers to the measure of lost of economic efficiency because of the optimum quantity of goods or services not produced. When supply and demand is not in equilibrium or the inefficiency in the allocation of resources could be termed as deadweight loss. An overvalued product giving under utility can be a deadweight loss.
An imposition of tax on producer either in competitive market or in a monopoly could leads to an increase in the deadweight loss. In the case of a competitive market, an imposition of tax may increase the price of a particular commodity thus reducing the utility derived from that. Thus can lead to inefficient market equilibrium where the demand falls lower than the optimum level. Thus the reduced demand could affect the production and the revenue from the good. The change in demand depends upon whether the good is price elastic or not. Also, the level of tax imposed or the rate at which the tax is increased could also affect the level of demand. Thus an increased tax will further leads to higher deadweight loss in the competitive market.
In the case of monopoly, an imposition of tax may not reduce the demand for the commodity as much as in the competitive market. But the level at which the tax is increased could affect the utility of the consumer thus creating a higher deadweight loss. If the tax imposed is too high, the chances of demand to fall deeply cannot be ignored since the consumer may find high disutility from the consumption of good in the monopoly market