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An answer schedule for a practice exam I am doing states that when a subsidy is placed on a a good by the government, there is a loss of allocative efficiency.

I have also learnt from this video that when supply and demand change, the market will still be allocatively efficient, although the amount of consumer and producer surplus will change. However, the video does not take into account dead-weight loss.

When a subsidy is placed on a good by the government, there is obviously a loss in welfare due to the dead weight loss. By my question is this: is there still a point of allocative efficiency in the market of a good with a subsidy, or is there no longer allocative efficiency at all when there is a dead weight loss?

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  • $\begingroup$ Are you asking about the existence of consumer and producer surplus when a market is allocatively efficient? Or can a market where there is a surplus of goods be allocatively efficient? $\endgroup$
    – 123
    Mar 31 '20 at 1:44
  • $\begingroup$ @123 yep the second one $\endgroup$ Mar 31 '20 at 1:47
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    $\begingroup$ K. I think I managed an answer that gives insight to both :) $\endgroup$
    – 123
    Mar 31 '20 at 1:50
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allocative efficiency occurs whenever total market surplus is maximized. This occurs whenever price is equal to the ‘free market’ equilibrium price. There is no surplus of goods at this equilibrium price. There is no DWL at this equilibrium. If there exists DWL, the market is not operating at the 'free market' (as phrased in a comment below) or the ‘unfettered’ equilibrium and the market is not allocatively efficient. To be clear, this market will still operate at some equilibrium. However, this equilibrium will not be efficient.

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  • $\begingroup$ Thanks a lot. There won't be a point of market equilibrium when there is a DWL, right? $\endgroup$ Mar 31 '20 at 1:58
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    $\begingroup$ There is still presumably a point of market equilibrium (defined by the equilibrium price and quantity) but the market is not operating at that equilibrium. $\endgroup$
    – 123
    Mar 31 '20 at 1:59
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    $\begingroup$ For example, consider a market wherein a government implements a price ceiling below the equilibrium price. This market will not operate at the equilibrium, even though there is an equilibrium price. If the government removed the price ceiling, the market would converge to the equilibrium. $\endgroup$
    – 123
    Mar 31 '20 at 2:02
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    $\begingroup$ Yes. I took that as as implicit assumption of the post based on how the original poster discussed the addition of a subsidy and seems to watch to compare a market with a subsidy to a 'free' or 'perfect' market. So the market will not be at the free-market equilibrium. Of course it can still reach some other equilibrium...namely the equilibrium prices and quantities under some distortionary tax, some subsidy, some ceiling, etc. $\endgroup$
    – 123
    Mar 31 '20 at 5:31
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    $\begingroup$ Allocative efficiency of p,Q are at the p*,Q* that correspond to ‘free market’ equilibrium. $\endgroup$
    – 123
    Apr 3 '20 at 0:30

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