2.8(2) Market failure - merit goods and demerit goods

What types of goods causes major market failure that requires government intervention?

• merit goods (under-consumed)

• demerit goods (over-consumed)

• public goods (not provided by the market)

Merit goods

Goods that society says people should consume because they are associated with significant social benefits.

example: healthy food, housing, museum…

How are merit goods an example of market failure?

1. They are underconsumed in a free market because consumers underestimate the true benefits, only focus on private benefits. MSB>MPB

   → underconsumption because they dont recognise the value of external positive effects

2. Producers under-produce merit goods because the market price doesn’t reflect these external social benefits

→ producers dont get paid for these extra social benefits so they do not produce enough

Undervalued private benefit

consumers don’t fully realise or appreciate how much benefit they get from consuming a good - they undervalue it

→ so they demand less of the good than what is actually good for them or for society

But why do they undervalue it?

1. don’t have full information/ don’t realise

2. focus only on short-term benefits and ignore long-term gains

3. don’t see or care about the positive effect on society

(MPB<MSB) = because consumers ignore external benefits to society

Demerit goods

goods that society says people should not consume because their consumption is associated with significant social costs

example: cigarets, alcohol

→ lead no negative external costs

How are demerit goods an example of market failure?

Because they tend to be over consumed in free markets.

→ Without any state intervention in a free market, resources will be overallocated.

Overvalued private benefits

Consumers think they get more benefit from a good than they actually do - they overestimate its value.

→ so they consume more of the good than is actually good for them or for society

But why do they undervalue it?

1. ignore or underestimate the negative effects on themselves or others

2. focus on short-term pleasure and ignore long-term harm

3. don’t consider external costs

(MPB>MSB) = because consumers overvalue the benefit to themselves