In the deadweight loss formula, what do 'b' and 'h' refer to?

In the context of deadweight loss associated with taxation, 'b' and 'h' specifically refer to components of the tax wedge that forms in the market. The deadweight loss represents the lost economic efficiency when the equilibrium outcome is not achievable due to a tax or other market distortion.

The base ('b') in this formula indicates the quantity reduction in the market due to the imposition of a tax, while the height ('h') refers to the difference between the price consumers pay and the price producers receive as a result of the tax. This imbalance creates a triangle on the supply and demand graph, which visually represents the lost surplus that occurs: the area of the triangle illustrates the economic transactions that do not take place because of the tax, leading to inefficiencies in the market.

Understanding these elements is crucial because they highlight how taxes can lead to reduced market activity, adversely affecting both consumer and producer surplus. This triangle configuration helps in quantifying the economic waste that a tax imposes on the economy, which would not exist in a tax-free environment.