4.1.8.5 - Merit goods & Demerit goods

Merit Good

A good that is underconsumed because consumers underestimate the benefits to themselves of consuming it (imperfect information)

- Information Failure

- Positive Externalities

Demerit Good

A good that is overconsumed because consumers underestimate the costs to themselves of consuming it (imperfect information)

- Information Failure

- Negative Externalities

What does the classificiation of merit & demerit goods depend on?

Value judgements

Imperfect Information

Occurs when people have inaccurate, incomplete, misleading, or misunderstood information which leads them to make wrong/suboptimal choices

Merit Good Chain of Analysis

- In a free market, said good may lead to market failure due to it being a merit good.

- This is because information failure arises when consumers don't know the full benefits to themselves of consumption.

- For example, [application] vegetables improve immune system

- As a result, consumers underestimate the private benefits of consuming the merit good. This often occurs as a result of short-term bias in decision-making.

- This causes consumers' actual demand to be determined by information that is only partial (shown by D (partial)), so the free-market equilibrium occurs at point A at Pm,Qm

- However, with full information about the good the demand would be higher at D (full), which results in the social optimum being at point C at Ps,Qs

- Therefore, information failure results in consumers underestimating the benefits of consuming the good so causes underconsumption

- There is under allocation of scarce resources to the good, resulting in deadweight welfare loss shown by area ABC

- Therefore, the free market mechanism has caused allocative inefficiency, resulting in partial market failure.

Demerit Good Chain of Analysis

- In a free market, said good may lead to market failure due to it being a demerit good.

- This is because information failure arises when consumers attribute goods with benefits that are not true or fail to take account of long-term costs of consumption.

- For example, [application] sugary drinks can lead to obesity, diabetes, cancer.

- As a result, consumers overestimate the private benefits & underestimate the private costs of consuming the demerit good. This often occurs as a result of short-term bias in decision-making.

- This causes consumers' actual demand to be determined by information that is only partial (shown by D (partial)), so the free-market equilibrium occurs at point A at Pm,Qm

- However, with full information about the good the demand would be lower at D (full), which results in the social optimum being at point C at Ps,Qs.

- Therefore, information failure results in consumers overestimating the benefits of consuming the good so causes overconsumption of the good.

- There is over allocation of scarce resources to the good, resulting in deadweight welfare loss shown by area ABC

- Therefore, the free market mechanism has caused allocative inefficiency, resulting in partial market failure.

Assymetric Information Application

15-30% of household food waste stems from the premature disposal of products based on misunderstanding the best before date.