Define deadweight loss
Deadweight loss is the decrease in economic efficiency that occurs when a good or service is not priced and produced at its pareto optimal level. When output is at its pareto optimal point, the price, production, and consumption of a good cannot be altered for one person's benefit without making at least one other worse off. In a perfectly competitive market, products are priced at the pareto optimal point.
When deadweight loss occurs, it comes at the expense of either the consumer economic surplus or the producer's economic surplus. Consumer surplus is the gain that consumers receive when they are able to purchase a product for less than the price they are willing to pay; producer surplus is the benefit producers receive when the sell a product for more than they are willing to sell for. While price controls, subsidies and other forms of market intervention might increase consumer or producer surplus, economic theory states that any gain would be outweighed by the losses sustained by the other side. This net harm is what causes deadweight loss.
Deadweight loss can be visually represented on supply and demand graphs. Known as Harberger's triangle, the deadweight loss equals the area within the following three points:
Deadweight loss: This chart illustrates the deadweight loss created when a price floor is instituted on the market for a good. The amount of deadweight loss is shown by the triangle highlighted in yellow. This area is known as Harberger's triangle.