Market Failure: Merit & Demerit Goods (AQA A Level Economics)

• Merit goods are products that are beneficial for society but the free market does not provide enough of them
• Demerit goods are products which have harmful impacts on consumers or society
   
• Value judgements play a role in determining whether goods are classified as merit or demerit goods
• Some goods are clearly defined as being a merit or demerit good, such as education (merit good) and illegal drugs (demerit good)
• The classification of some goods can be unclear as it is based on a value judgement
   

Classification of Goods Based on Value Judgements

• Consumers under-consume merit goods as they do not fully recognise the private or external benefits
• Merit goods are often under-provided in a free-market and are a cause of partial market failure
  • Common examples include vaccinations, education and electric cars
  • Governments often have to subsidise these goods in order to lower the price and/or increase the quantity demanded

Diagram: Merit Goods in a Free Market 

Positive externalities from the consumption of merit goods

Diagram analysis

• The marginal social costs (MSC) are assumed to be equal to the marginal private cost (MPC) as the focus is on the consumer (demand side) of the market
• The optimal allocation of resources for society would generate an equilibrium where marginal social benefit (MSB) = MSC
  •  At P_eQ_e where there is no market failure
    
    
• The free-market equilibrium for merit goods is under consumed as consumers fail to consider the external benefits from consumption
  • This is shown at P_eQ_e where the MPB=MSC
    
    
• The quantity consumed at Q_e is below the socially optimal level resulting in an under-consumption and a partial market failure. There is a deadweight loss to society (pink triangle)
• To be socially efficient, more factors of production should be allocated to producing this good/service

• Consumers over-consume demerit goods to a greater extent than is considered desirable by society
• Consumers are unlikely to consider all of the consequences when making consumption decisions
  • The social costs of consumption outweigh the private costs 
     

• Demerit goods are often over-provided in a free-market and are a cause of partial market failure
  • These goods are usually addictive and harmful for consumers, e.g. gambling, alcohol, drugs, sugary foods/drinks
  • Governments often have to regulate these goods in such a way that they raise the prices and/or limit the quantity demanded
    
    

• The activities of producers can generate significant external costs, e.g. pollution caused by coal-burning power stations during the production of electricity
  • However, electricity is considered to be a merit good
  • The smoke is a by-product and not a good/service
• For this reason, economists usually consider demerit goods to be goods used in consumption

Diagram: Demerit Goods in a Free Market 

Negative externalities from the consumption of demerit goods

Diagram analysis

• The MSC is assumed to be equal to the MPC as the focus is on the consumer (demand) side of the market
• The optimal allocation of resources for society would generate an equilibrium where MSB = MSC
• At P_eQ_e where there is no market failure
  
  

• The free-market equilibrium for demerit goods is over consumed as consumers fail to consider the external costs from consumption
  • This is shown at P_eQ_e where the MPB=MSC
    
    
• The quantity consumed at Q_e is above the socially optimal level, resulting in overconsumption and a partial market failure. There is a deadweight loss to society (pink triangle)
• To be socially efficient, fewer factors of production should be allocated to producing this good/service

• A lack of information can make it difficult for consumers to make decisions about a good or service 
• Due to imperfect information, consumers may have incomplete or inaccurate information about the external consequences associated with merit or demerit goods
  
  
• Merit goods are often under-provided, due to a lack of demand. Consumers are often unaware of the positive effects of consuming such goods
   
• Demerit goods are often over-provided, due to high demand as consumers are ill-informed regarding the consequences of consuming such goods
  • Efforts to educate the public by the government, such as public awareness campaigns can help consumers make more informed choices