3.8.5 - Merit and Demerit Goods

Question 1

What is a merit good?

Answer 1

A good for which the social benefits of consumption outweigh the private benefits.

Value judgements are involved in deciding that a good is merit.

Question 2

Why do merit goods differ from public goods?

Answer 2

Public goods are non-excludable and non-rival and therefore, a market will likely fail to provide any of the good.

Merit goods are provided by the market, but are likely underprovided leading to a partial market failure.

Question 3

What is information failure?

Answer 3

People make wrong decisions because they do not possess or they ignore relevant information.

This is often due to myopia about the future.

Question 4

What is a social benefit?

Answer 4

The total benefit of an activity, including external benefit as well as private benefit.

As an equation:
Social benefit = Private benefit + external benefit

Question 5

What are the two most important characteristics of merit goods?

Answer 5

Postitive externalities in consumption
Information failures about the good

Question 6

What is the link between merit goods and positive externalities?

Answer 6

When a person consumes a merit good, the resulting externalities benefit other people.

i.e. healthy people spread less disease

The social benefit from consumption is greater than the private benefit enjoyed by the healthy person.

Question 7

What is the link between merit goods and information failure?

Answer 7

The long-term benefits of consuming merit goods outweigh the short-term benefits of consumption.

Individuals tend to take into account short-term benefits due to their time myopia.

An excellent example of this is education, a merit good that some students choose to underconsume as they do not value it at the time.

Question 8

Draw a under-consumed merit good diagram.

Answer 8

Question 9

What is a subsidy?

Answer 9

A payment made by a government or other authority, usually to producers, to incentivise increased consumption of a good.

Question 10

How can a government correct a market failure of under-consumption of a merit good?

Answer 10

• Nationalise the provision of the good
• Subsidise the good to increase consumption up to the socially optimal level.

Question 11

What is a demerit good?

Answer 11

Goods for which the social costs of consumption exceed the private costs.

Value judgements are involving in deciding if a good is demerit or not.

Question 12

What is a social cost?

Answer 12

The total cost of an activity, including the external cost as well as the private cost.

Social cost = Private cost + external cost.

Question 13

What are the two key factors of demerit goods?

Answer 13

• Negative externalities
• Information failures

Question 14

Why is it important to remember value judgements are vital in considering if a good is merit or demerit?

Answer 14

Each person has a different judgement for some goods, e.g. abortion, contraception, vaccination etc.

Question 15

Which economists do not believe in merit / demerit goods?

Answer 15

Some free-marketeers.

Question 16

Why do some economists not think there are demerit or merit goods?

Answer 16

Free-market economists are libertarians who believe people should be able to make their own decisions to judge what is best for them.

They believe it is not the state’s role to intervene in an individuals behaviour, unless it harms other people. (Harm principle - John Stuart Mill)

Question 17

Why do some economists disagree with others over de/merit goods not existing?

Answer 17

Anti-libertarians (interventionists) argue that overconsumption of demerit goods and underconsumption of merit goods invariably leads to other people being harmed.

Taxation, subsidy and regulation are perfectly justified as altering individual behaviour.

Question 18

What type of economists lie between the two main approaches towards merit and demerit goods?

Answer 18

Behavioural economists believe that people should be free to choose, but governments should use appropriate policies to ‘nudge’ people in the socially optimal direction.

Question 19

How can a government bring about socially optimal consumption of this good via taxation?

Answer 19

Introduce an indirect tax between points B and C which would increase the price to P2 and therefore reduce consumption to Q2 (where MSB = MSC)

Question 20

What do some economists argue about the causes of merit and demerit goods?

Answer 20

Some place more importance on information failure than the externalities they generate.

Individuals are more likely to take into account short-term benefits and costs than long-term benefits and costs.

Question 21

Why do humans tend to consider short-term benefits and costs above long-term benefits and costs?

Answer 21

The uncertainty surrounding the long-term makes people more likely to consider the short-term ahead of the long-term.

i.e. people might not pay for a specialist surgeon under their healthcare as they do not need it right at that moment, and might not need it in the future.

Question 22

What is moral hazard?

Answer 22

The tendency of individuals and firms, once insured against some contigency to behave so as to make that contigency more likely.

Question 23

What problems does private healthcare provision suffer from so as to make market failure more likely?

Answer 23

Moral hazard
Adverse selection

Question 24

Why is moral hazard a cause of market failure in the private healthcare insurance market?

Answer 24

People who are covered by the health insurance tend to act less carefully about their health as they know the insurance firm will cover the bill.

Therefore, insurance companies charge higher insurance premiums than they actually need to.