Question: Explain the differences between merit goods, demerit goods and public goods.
- Add introduction
- Define all key terms: merit goods, demerit goods, and public goods.
- State the similarities and differences
- Add conclusion
- Merit Goods: Merit goods are products, such as education, which consumers may undervalue but which the government believes are ‘good’ for consumers as they exhibit positive externalities. Merit goods would be therefore be under – provided in a pure free – market economy. People do not take account of positive externalities when they decide how much to consume of a good so they may therefore under-consume the good.
- Public Goods: Public goods are goods that would not be provided in a pure free – market system. This is because they display the characteristics of non-rivalry and non excludability. Non- rivalry means that consumption by one person does not reduce the amount available for another (e.g. street lighting) and non-excludability means that once the goods is provided it is not possible to stop people benefiting from it (e.g. lighthouses).
- Demerit Goods: Demerit goods are goods which have negative externalities resulting from their consumption. This means that consumption of the goods result in external costs – costs that fall on people other than those consuming the goods. An example of demerit good is cigarettes. Smoking causes additional health cost (external costs) that are paid by the rest of the population.
Triple A Textbook:
Demerit goods are goods which are deemed to be socially undesirable, and which are likely to be over-produced and over-consumed through the market mechanism. Examples of demerit goods are cigarettes, alcohol and all other addictive drugs such as heroine and cocaine.
The problem arises from the fact that so long as an effective demand is present, such goods are, in all probability, going to be extremely profitable to produce, and this is all that a price system takes into account – the market neither possesses a ‘heart’ to enable it to help those in need, nor is it inherently able to make value judgements about which commodities are good or bad for society as a whole: it is prices and profits which act as the ‘guiding light’ to resource allocation.
However, the consumption of demerit goods imposes considerable negative externalities on society as a whole, such that the private costs incurred by the individual consumer are less than the social costs experienced by society in general; for example, cigarette smokers not only damage their own health, but also impose a cost on society in terms of those who involuntarily passively smoke and the additional cost to the National Health Service in dealing with smoking-related diseases. Thus, the price that consumers pay for a packet of cigarettes is not related to the social costs to which they give rise i.e. the marginal social cost will exceed the market price and overproduction and over-consumption will occur, causing amisallocation of society’s scarce resources. This is illustrated in figure 1 below.
Merit goods generate substantial positive externalities
Merit goods confer benefits on society in excess of the benefits conferred on individual consumers; in other words, there is a divergence between private and social costs and benefits, as the social benefits accruing to society as a whole from the consumption of such goods tend to be greater than the private benefits to the individual. This divergence means that the private market cannot be relied upon to ensure an efficient allocation of society’s scarce resources. The problem is that individual consumers and producers make their decisions on the basis of their own, internal costs and benefits, but, from the standpoint of the welfare of society at large, externalities must be considered. This point can be illustrated in relation to health care and education:
Health care generates a number of positive externalities; for example, if all people receive adequate levels of healthcare, the nation’s workforce is likely to be fitter and healthier, less working days would be lost through sickness, and this would have beneficial effects on the level of output and economic growth; vaccinations and preventative health care which prevent the spread of contagious diseases such as small-pox and whooping cough, clearly not only benefit the individuals receiving the treatment, but also the rest of society at large. Indeed, a major reason for the relatively weak economic performance of many of the poorer countries of the world is the widespread incidence of ill-health and disease amongst their populations.
Similarly, in the case of education, there are a number of positive externalities from which society at large may benefit, which may not directly accrue to the individual pupil/student. Individuals clearly derive private benefits from higher levels of education as, for example, earning capacity is to a considerable extent a function of educational attainment. However, society at large receives the benefits of a more highly skilled, adaptable and thus more efficient workforce, which is one of the key ingredients of economic success – the West German post-war ‘economic miracle’ has, in part, been attributed to its highly educated and trained workforce. Society also benefits in less tangible ways as it could be argued that educated people are less prone to crime and racial intolerance, although this argument is obviously not foolproof!
The important point then is that if people had to pay privately through the market for such merit goods as health and education they would consider only their private benefits and their private costs and would thus consume too little from the point of view of the best interests of society as a whole. This problem of under-consumption is illustrated in Figure 1 below.
Pure public goods are ones that when consumed by one person can be consumed in equal amounts by the remainder of society, and where the possibility of excluding others from consumption is impossible.
Examples of public goods are:
- national defence;
- the police service;
- street lighting;
- flood-control dams;
- public drainage.
It is likely that the market, left to itself, will seriouslyunder-produce such goods, or possibly not produce them at all. This is because the market will only provide goods for which a profit can be made, andpure public goods possess two important properties that together make their production on the basis of private profitability extremely difficult. These features are:
- non-rivalry ( or non-diminishability);
- non- excludabilty.
Firstly, consider the characteristic of non-rivalry: this means that one person’s use of the public good does not deprive any other person of such use or does not diminish the amount available to others; for example, if one person enjoys the benefits of being protected by the police-force, a flood control dam or the national defence system, it does not prevent everyone else doing the same; similarly, if one person benefits from walking along a street at night-time which is paved, free of pot-holes, and well-lit, the benefits and the availability to others would not be diminished.
Secondly, consider the characteristic of non-excludability: this means that when the public good is provided to one person, it is not possible to prevent others from enjoying its consumption – sometimes summarised as: provision at all means provision for all; thus, if a police force, a flood- control dam or a national defence system is successful in offering protection to citizens of a country, once it has been provided it is impossible to exclude anyone within the country from consuming and benefiting from such goods; similarly, for a paved and well-lit public street – nobody can be prevented from enjoying its benefits.