Merit Goods Are Under-Consumed Relative to the Social Optimum
Definition
Merit good: a good, such as education or healthcare, that is under-consumed in the free market because consumers undervalue its private benefits, often owing to imperfect information.
- A merit good is judged to be under-consumed relative to what is socially desirable.
- People often undervalue the private benefits, or there are positive externalities in consumption.
- Examples include healthcare and education.
Note
- The merit-good label rests on a value judgement, linked to imperfect information.
- Merit goods are usually rival and excludable, unlike public goods.
The Market Under-Provides Merit Goods
- Consumers weigh only the benefits they perceive, which they tend to underestimate.
- Positive externalities mean the wider benefit to society is ignored too.
- So the market delivers less than the socially optimal amount.
Example
- People often under-use preventive healthcare, valuing it less than it is worth.
- Education brings gains to the individual and to wider society over time.
Demerit Goods Are Over-Consumed Relative to the Social Optimum
- A demerit good is judged to be over-consumed relative to what is socially desirable.
- People often overvalue the private benefits, or there are negative externalities in consumption.
- Examples include tobacco, alcohol and gambling.
Note
- The demerit-good label rests on a value judgement, reinforced by imperfect information.
- Negative externalities in consumption make the social cost exceed the private cost.
The Market Over-Provides Demerit Goods
- Consumers act on an overestimate of the private benefit.
- They ignore the external costs their consumption imposes on others.
- So the market delivers more than the socially optimal amount.
Example
- Smoking harms the smoker and, through second-hand smoke, those nearby.
- Heavy drinking adds costs to the NHS and to public order.
Classification Rests on a Value Judgement
- Whether a good counts as merit or demerit depends on a normative view of what is desirable.
- Reasonable people can disagree about how far the state should encourage or discourage consumption.
- The case rests on information failure and externalities in consumption, not taste alone.
Imperfect Information Distorts Consumption
- Imperfect information means people act on a perceived benefit that differs from the actual benefit.
- If they underrate a good's benefit, they under-consume it, as with merit goods.
- If they overrate it, they over-consume it, as with demerit goods.
- The gap between perceived and actual benefit is the source of the welfare loss.
Example
- Underrating the value of vaccination shifts perceived benefit below the true level.
- The market settles left of the social optimum, and welfare is lost.
UK Policy Responds With Subsidies, Taxes, Regulation and Information
- For merit goods, the government can subsidise consumption, provide it directly, or run information campaigns to correct the under-valuation.
- For demerit goods, the government can tax consumption, regulate or ban it, or run information campaigns to correct the over-valuation.
- The right tool depends on the underlying cause, since a tax targets an externality while an information campaign targets misperception.
Example
- The UK funds childhood vaccination programmes and provides free NHS healthcare and state education because they are judged to be under-consumed merit goods.
- The UK taxes tobacco and alcohol heavily and levies a Soft Drinks Industry Levy, the sugar tax, on high-sugar drinks because they are judged to be over-consumed demerit goods.
Intervening in These Markets Involves a Trade-Off
- Subsidising or providing merit goods and taxing or regulating demerit goods can shift consumption towards the social optimum and correct the information failure behind the misallocation.
- Against this, because the merit or demerit label rests on a value judgement, intervention risks paternalism, with the state overriding the choices of informed adults.
- Each instrument can also misfire, since an over-set tax, a ban that fuels a black market or a subsidy with a large opportunity cost can create government failure.
- The scale of any correction depends on elasticity, as a tax on an inelastic demerit good such as tobacco changes quantity little and mainly raises revenue.
- On balance, intervention is justified where the information failure or externality is large and measurable, so the deciding factor is how confident policymakers can be about the true social value and the size of the behavioural response.
Separate Merit and Demerit Goods From Public Goods
Exam technique
- State that merit and demerit goods are rival and excludable, so they are not public goods.
- Link under- or over-consumption to imperfect information and to externalities in consumption.
- When judging demerit-good policy, weigh a tax against a ban.
Common Mistake
- Do not treat merit or demerit goods as public goods; they are usually rival and excludable.
- Do not assume a demerit good should simply be banned, as bans ignore black-market and wider welfare trade-offs.
Self review
- Define a merit good and a demerit good.
- Why does the market under-provide merit goods and over-provide demerit goods?
- Why is the classification a value judgement?
- How does imperfect information distort consumption?
- How do merit and demerit goods differ from public goods?
