Market Failure/Gov Intervention

Question 1

Why does overconsumption of demerit goods occur?
Provide examples

Answer 1

• Misinformation: e.g. historical belief that fat was responsible for health issues and sugar was harmless.
• Bounded rationality: people may know sugar/cigarettes are bad for them but eat/smoke them because they value short term utility over long term or may be overly optimistic that the consequences won’t actually happen to them.
• Producers taking advantage of bounded rationality: e.g. shops placing snacks next to the checkout queue to tempt consumers to pick them up.
• So the full costs of consumption are not fully internalised so MPB > MSB

Question 2

Why does overconsumption of goods with negative externalities occur?

Answer 2

• Individuals only consider private benefits - such as convenience and mobolity when driving their car - and do not consider external costs such as air pollution and global warming.
• So MSB < MPB

Question 3

What are ways in which government can reduce overconsumption of demerit goods? Give examples.

Answer 3

• Indirect taxes: Sugar tax in 2016
• Information campaigns: Change4Life campaigns for healthier eating
• Regulation: Age restriction on alcohol & cigarettes
• Advertising ban: Ban on cigarette advertising in UK
• Minimum price: Minimum price of alcohol in Scotland
• Behavioural nudge: Graphic health warnings on cigarette packages
• Subsidies for alternatives: healthy snacks instead of unhealthy ones