Distortions (economics)

Distortions (economics)

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A distortion is a condition that creates economic inefficiency, thus interfering with economic agents maximizing "social welfare" when they maximize their own welfare.

In the idealized conditions of perfect competition
Perfect competition
In economic theory, perfect competition describes markets such that no participants are large enough to have the market power to set the price of a homogeneous product. Because the conditions for perfect competition are strict, there are few if any perfectly competitive markets...

 with no externalities, there is zero distortion at market equilibrium of supply and demand
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...

 where price
Price
-Definition:In ordinary usage, price is the quantity of payment or compensation given by one party to another in return for goods or services.In modern economies, prices are generally expressed in units of some form of currency...

 equals marginal cost
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...

 for each firm and product. More generally, a condition used to measure distortion is the deviation between the market price of a good and its marginal
Marginal cost
In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good...

 social cost
Social cost
Social cost, in economics, is generally defined in opposition to "private cost". In economics, theorists model individual decision-making as measurement of costs and benefits...

, that is, the difference between the marginal rate of substitution
Marginal rate of substitution
In economics, the marginal rate of substitution is the rate at which a consumer is ready to give up one good in exchange for another good while maintaining the same level of utility.-Marginal rate of substitution as the slope of indifference curve:...

 in consumption and the marginal rate of transformation in production. Such a deviation may result from government regulation
Regulation
Regulation is administrative legislation that constitutes or constrains rights and allocates responsibilities. It can be distinguished from primary legislation on the one hand and judge-made law on the other...

, monopoly
Monopoly
A monopoly exists when a specific person or enterprise is the only supplier of a particular commodity...

, tariff
Tariff
A tariff may be either tax on imports or exports , or a list or schedule of prices for such things as rail service, bus routes, and electrical usage ....

s and import quota
Import quota
An import quota is a type of protectionist trade restriction that sets a physical limit on the quantity of a good that can be imported into a country in a given period of time....

s, which in theory may give rise to a certain kind of behavior called rent seeking
Rent seeking
In economics, rent-seeking is an attempt to derive economic rent by manipulating the social or political environment in which economic activities occur, rather than by adding value...

. Other sources of distortions are uncorrected externalities, different tax rates on goods or income, inflation, and incomplete information. Each of these may lead to a net loss in social surplus.

See also


  • Excess burden of taxation
    Excess burden of taxation
    In economics, the excess burden of taxation, also known as the distortionary cost or deadweight loss of taxation, is one of the economic losses that society suffers as the result of a tax. Economic theory posits that distortions changes the amount and type of economic behavior from that which...

  • Imperfect competition
    Imperfect competition
    In economic theory, imperfect competition is the competitive situation in any market where the conditions necessary for perfect competition are not satisfied...


  • Government failure
    Government failure
    Government failure is the public sector analogy to market failure and occurs when a government intervention causes a more inefficient allocation of goods and resources than would occur without that intervention...

  • Lump-sum tax
    Lump-sum tax
    A lump-sum tax is a tax that is a fixed amount, no matter the change in circumstance of the taxed entity....


  • Market failure
    Market failure
    Market failure is a concept within economic theory wherein the allocation of goods and services by a free market is not efficient. That is, there exists another conceivable outcome where a market participant may be made better-off without making someone else worse-off...

  • Optimal tax
    Optimal tax
    Optimal tax theory is the study of how best to design a tax to minimize distortion and inefficiency subject to increasing set revenues through distortionary taxation. A neutral tax is a theoretical tax which avoids distortion and inefficiency completely....

  • Welfare economics
    Welfare economics
    Welfare economics is a branch of economics that uses microeconomic techniques to evaluate economic well-being, especially relative to competitive general equilibrium within an economy as to economic efficiency and the resulting income distribution associated with it...