Question

What is the relationship between deadweight loss and the size of a tax?

a. As the size of a tax rises the deadweight loss becomes smaller.
b. A small tax causes a large deadweight loss.
c. The dead weight loss is constant irrespective of the size of a tax.
d. The dead weight loss grows larger and larger as the size of a tax rises.

Answer 1

Deadweight loss increases with the size of the tax, causing a loss in economic efficiency as it leads to fewer market transactions and a reduction in the total surplus of society.

Step-by-step explanation:

The relationship between deadweight loss and the size of a tax is that the deadweight loss tends to increase as the size of the tax increases. When a tax is imposed on a good or service, it creates a wedge between the price buyers pay and the price sellers receive. This tax wedge leads to a decrease in the quantity bought and sold, moving the market away from the efficient equilibrium.

The result is a loss in economic efficiency because the market is no longer maximizing the total surplus that can be achieved without the tax. The deadweight loss represents the total surplus lost due to the tax, wherein consumers and producers engage in fewer transactions than they would in a tax-free scenario. As taxes grow larger, they discourage even more transactions, leading to a larger area of deadweight loss, meaning more social surplus is lost, and the economic outcome is more inefficient.