When a taxed good is normal, using the (uncompensated) demand curve to estimate deadweight loss will over-state the actual deadweight loss.

Question

Quizplus · Accepted Answer

The uncompensated demand curve does not account for the income effect of a tax, only the substitution effect. When a good is normal, the income effect works to reduce the quantity demanded further than what the substitution effect alone would suggest, leading to an overestimation of deadweight loss if only the uncompensated demand curve is used.

When a Taxed Good Is Normal, Using the (Uncompensated) Demand