Public goods, merit and demerit goods and information failure

Last time

Before we start: last time, in Production possibility curves, specialisation and the division of labour, you learned these points. Here they are again on one card. Keep them in mind, because today builds on them.

Goods markets get wrong

Markets fail to provide some goods at all, and provide too little or too much of others. Public goods, merit goods and demerit goods are the main examples. This lesson explains why, using the ideas of excludability, rivalry and information failure.

Public goods

A pure public good is non-excludable: once provided, non-payers cannot be stopped from benefiting. And non-rival: one person's use does not reduce the amount available to others. Examples: national defence, street lighting, flood defences and lighthouses.

The free-rider problem

Because people can benefit without paying, each has an incentive to let others pay: the free-rider problem. So firms cannot earn revenue, and a free market provides none, or far too little: complete market failure, a missing market. So public goods are usually provided by the government, paid for by taxes.

Public goods only in mixed economies?

In a pure market economy, public goods would not be provided, so state provision is needed: this supports the mixed economy. But some public goods can be provided privately, through sponsorship, or by charging where technology makes exclusion possible, such as toll roads. And quasi-public goods, such as roads, are only partly non-excludable and non-rival.

Merit goods

A merit good is one that is under-consumed in a free market, because consumers underestimate its benefits: education, health care, vaccinations. This is due to information failure: people lack full information about the long-term private benefits. Merit goods often also have positive externalities, benefits to third parties.

Demerit goods

A demerit good is over-consumed because consumers underestimate its harm: cigarettes, alcohol, sugary drinks. Again, information failure: people underestimate the long-term damage to themselves. They often have negative externalities, such as passive smoking or the costs of drink-driving.

Correcting merit and demerit goods

Merit goods: subsidies, direct provision free of charge, and information campaigns. Demerit goods: indirect taxes, regulation and bans, minimum ages, and information campaigns. Each policy has limits, so the best choice depends on the good and on consumer behaviour.

Will a subsidy always work?

A subsidy lowers the price, so consumption of the merit good should rise. But if demand is price inelastic, or the barrier is lack of information, not price, consumption may rise only a little. Subsidies also have an opportunity cost and may create government failure. So combine with information or provision.

Types of goods compared

The goods compared on the key features.

Mistakes that lose marks

Mistake one: calling education a public good. It is excludable and rival, so it is a merit good. Mistake two: defining merit goods as goods the government provides. Mistake three: saying a subsidy always works, without considering elasticity and information. The fix: characteristics, information failure, and evaluation.

The full-marks tip

The full-marks tip: classify a good by its characteristics, not by who provides it. Evaluate policies with price elasticity, information, and opportunity cost.

On one card

So, on one card: public, merit and demerit goods. Keep it for revision.