Merit and demerit goods

Merit goods

Education or health care
good or service for which the social benefits of consumption enjoyed by the whole community exceed the private benefits received by the consumer
Comsumption by an individual produces positive externalities that benefit the wider community
The misallocation of resources are caused by the under-consumption of merit goods

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The social cost to the whole community which result from the consumption of a demerit good, exceed the private costs incurred by the consumer
This is because consumption by an individual produces negative externalities that harm the wider community
Tobacco, alcohol
The private costs can be measured by the money cost of consuming the good, together with any health damage suffered by the person comsuming the good
The social costs of consumption also include the cost of the negative externalities
Over consumption of demerit goods cause a misallocation of resources

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Individuals consuming merit and demerit goods may not act in their own best interest because they only consider the short-term utility maximisation rather than the long-term utility maximisation
The long term private benefits of consuming a merit good such as education exceed the short term private benefits
Similarly with a demerit good such as tobacco, the long term private costs exceed the short term private costs
The government should therefore encourage the consumption of merit goods and discourage the consumption of demerit goods

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Can be seen as a form of market failure
Argued that a completely unregulated market economy produces significant inequalities
Some economists believe that government intervention to redistribute income and wealth destroys incentives that are vital for a market economy to funtion efficiently
Leads to worse problems of government failure

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Form of market failure
Occupational immobility
Geographical immobility
This means that economic resources are no fully held back by labour shortages in areas benefiting from full employment
Free market theory - the problem can be cured through wage rates rising in areas of labour shortage
However - the market mechanism fails to solve the problem, and labour shortages and surpluses persist

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