Merit and Demerit Goods

What are merit goods?

Merit goods are goods or services that are considered to be beneficial to individuals and society as a whole, but are often under-consumed in a free market economy. These goods have positive effects on health, education, or the environment, but individuals may not consume them in optimal quantities.

Merit goods examples

Examples of merit goods include education, healthcare services, public transportation and renewable energy.

1. Education is often considered a merit good because it provides benefits not just to the individual student, but also to society as a whole. Education can lead to higher levels of economic growth, increased civic engagement, and improved health outcomes.
2. Access to healthcare services can improve the overall health of a population, which can lead to increased productivity and reduced healthcare costs over time. In addition, healthy individuals are better able to participate in the workforce and contribute to the economy.
3. The use of renewable energy sources like solar, wind, and hydropower can help reduce greenhouse gas emissions and mitigate the negative effects of climate change. Investing in renewable energy can also create jobs and stimulate economic growth.
4. Access to public transportation can reduce traffic congestion, air pollution, and travel costs, while also increasing mobility and access to job opportunities. This can lead to increased economic activity and a more connected and cohesive society.

The characteristics of merit goods

Let’s study the main characteristics of merit goods.

Merit goods and positive externalities

Consumption of merit goods benefits society as a whole. These benefits outweigh the private benefits enjoyed by the individual due to positive externalities.

Let’s look at this example in a diagram. In Figure 1 below, S1 represents the market supply of healthcare. It represents the quantity of healthcare private healthcare providers are willing to supply at various price levels. D1 shows how much healthcare consumers are willing to buy. Q1 represents the quantity of private healthcare consumed at price P1.

On the other hand, D2 represents both the external benefits (positive externalities) and the individual benefits of consuming healthcare. Q2 shows the socially optimal level of healthcare, whereas Q1 shows the privately optimal level of healthcare. In the free market economy, the positive externalities of merit goods often go unnoticed, so consumption and production are under the socially optimal level.

The price of healthcare has to decrease to P2 in order to reach equilibrium at Q2. However, private suppliers are unwilling to supply at this price as it would decrease their profits significantly. To increase the supply of healthcare to S2, governments subsidise it. The vertical distance between S1 and S2 represents the unit size of the subsidy.

Fig. 1 - Effect of a subsidy on merit goods

Why are merit goods underprovided?

A merit good is under-provided and under-consumed because of the following factors:

• Imperfect Information: Consumers may not have access to all the information they need to make an informed decision about the benefits of the merit good, leading them to under-consume it.
• Presence of positive consumption externalities: The benefits of a merit good, such as education or healthcare, may extend beyond the individual who consumes it to society as a whole. However, these positive externalities are not factored into the individual's decision-making, resulting in an under-provision of the good.
• Poor decision-making: Individuals may prioritize short-term costs over long-term benefits, leading them to under-consume a merit good that would be beneficial in the long run. This can be exacerbated by factors such as income inequality, where individuals with lower incomes may prioritize immediate needs over long-term investments in merit goods such as education or healthcare.

What are demerit goods?

Demerit goods are the opposite of merit goods, as the social costs for the community are higher than the private costs for individual consumption. Private costs include the costs incurred by the individual for purchasing the good and the negative impact of the good on the individual. Social costs include the negative externalities that occur during the consumption of the good.

Demerit goods examples

Examples of demerit goods that can have destructive impacts on individuals and society as a whole include alcohol, tobacco, fast-food, single-use plastics, and gambling.

1. Tobacco products are widely recognized as a demerit good due to their negative effects on health, including an increased risk of lung cancer, heart disease, and other illnesses.
2. Excessive consumption of alcohol can lead to a range of health problems, including liver disease, mental health issues, and an increased risk of accidents and injuries. Alcohol can also contribute to social problems such as violence and crime.
3. Fast food and other high-calorie, low-nutrient foods are often considered demerit goods due to their contribution to obesity and related health problems. Overconsumption of these types of foods can also lead to increased healthcare costs and decreased productivity.
4. Single-use plastics such as straws, bags, and packaging contribute to environmental pollution and harm wildlife. These plastics take hundreds of years to degrade and can end up in our oceans and waterways, causing serious harm to marine life.
5. Gambling can be addictive and can lead to financial problems for individuals and their families. In addition, the promotion of gambling can lead to social issues such as crime and addiction.

The characteristics of demerit goods

Let’s study the main characteristics of merit goods.

Demerit goods and negative externalities

As we know, demerit goods create negative externalities. Looking at Figure 2 below, we can see that the sale of tobacco at market prices results in over-consumption. A privately optimal level of tobacco consumption happens at Q1, where prices are at P1. This is higher than the socially optimal level of tobacco consumption (Q2). Providing tobacco at free-market prices, therefore, results in overconsumption and overproduction.

As a result, governments can introduce taxes on the consumption of tobacco in an attempt to decrease the demand. This results in the supply curve shifting from S1 to S2, raising prices from P1 to P2 and allowing consumption to fall back to the socially optimal level. The vertical distance between S1 and S2 represents the unit size of the tax.

Fig. 2 - Taxation and demerit goods

Why are demerit goods overconsumed?

In the same way that merit goods are under-consumed, demerit goods are over-consumed. This is, again, due to imperfect information. Consumers often do not realise the extent of the harm caused by demerit goods which therefore leads to their over-consumption. Consumers also tend to ignore the negative externalities caused to society by consuming demerit goods.

Merit goods, demerit goods, and value judgements

Value judgments play a large role in determining which goods can be classified as merit and demerit goods. There are certain products that can clearly be defined as merit goods (like education and healthcare) and products that can clearly be defined as demerit goods (like tobacco and illegal drugs). However, due people’s different values and religions, there are certain goods for which the classification is not as easy. For example, some view contraception as a merit good and others as a demerit good. Therefore, the classification depends on the value judgment of the person making the classification.