3. Which of the following create deadweight loss? Which do not and are simply a transfer of surplus from one person to another? Explain your answer.
You have been evicted from your rent-controlled apartment after the landlord discovered your pet boa constrictor. The apartment is quickly rented to someone else at the same price. You and the new renter do not necessarily have the same willingness to pay for the apartment.
Since the apartment is rented quickly at the same price, there is no change (either gain or loss) in producer surplus. So any change in total surplus comes from changes in consumer surplus. When you are evicted, the amount of consumer surplus you lose is equal to the difference between your willingness to pay for the apartment and the rent-controlled price. When the apartment is rented to someone else at the same price, the amount of consumer surplus the new renter gains is equal to the difference between his or her willingness to pay and the rent-controlled price. So this will be a pure transfer of surplus from one person to another only if both your willingness to pay and the new renter’s willingness to pay are the same. Since under rent control apartments are not always allocated to those who have the highest willingness to pay, the new renter’s willingness to pay may be either equal to, lower, or higher than your willingness to pay. If the new renter’s willingness to pay is lower than yours, this will create additional deadweight loss: there is some additional consumer surplus that is lost. However, if the new renter’s willingness to pay is higher than yours, this will create an increase in total surplus, as the new renter gains more consumer surplus than you lost.
In a contest, you won a ticket to a jazz concert. But you can’t go to the concert because of an exam, and the terms of the contest do not allow you to sell the ticket or give it to someone else. Would your answer to this question change if you could not sell the ticket but could give it to someone else?
This creates deadweight loss: if you were able to give the ticket away, someone else would be able to obtain consumer surplus, equal to their willingness to pay for the ticket. You neither gain nor lose any surplus, since you cannot go to the concert whether or not you give the ticket away. If you were able to sell the ticket, the buyer would obtain consumer surplus equal to the difference between their willingness to pay for the ticket and the price at which you sell the ticket. In addition, you would obtain producer surplus equal to the difference between the price at which you sell the ticket and your cost of selling the ticket (which, since you won the ticket, is presumably zero). Since the restriction to neither sell nor give away the ticket means that this surplus cannot be obtained by anybody, it creates deadweight loss. If you could give the ticket away, as described above, there would be consumer surplus that accrues to the recipient of the ticket; and if you give the ticket to the person with the highest willingness to pay, there would be no deadweight loss.
Your school’s dean of students, who is a proponent of a low-fat diet, decrees that ice cream can no longer be served on campus.
This creates deadweight loss. If students buy ice cream on campus, they obtain consumer surplus: their willingness to pay must have been higher than the price of the ice cream. Your college obtains producer surplus: the price is higher than your college’s cost of selling the ice cream. Prohibiting the sale of ice cream on campus means that these two sources of total surplus are lost: there is deadweight loss.
Your ice-cream cone falls on the ground and your dog eats it. (Take the liberty of counting your dog as a member of society, and assume that, if he could, your dog would be willing to pay the same amount for the ice-cream cone as you.)
Given that your dog values ice cream equally as much as you do, this is a pure transfer of surplus. As you lose consumer surplus, your dog gains equally as much consumer surplus.