What are merit and demerit goods?
A merit good is a good that people under-value. It is more useful to them than they think, and it often brings external benefits to others. Examples: education, vaccines, health check-ups, pensions, helmets.
A demerit good is a good that people over-value. It is more harmful to them than they think, and it often brings external costs to others. Examples: cigarettes, alcohol, sugary drinks, gambling, recreational drugs.
So in a free market:
- Merit goods are under-consumed (and under-provided).
- Demerit goods are over-consumed (and over-provided).
Both are a market failure: resources go to the wrong amounts.
Information failure: the main cause
Information failure means people do not have, or do not use, the full and correct information they need to choose well.
- Long-term effects are hard to see. Smoking's harm comes years later. Education's reward comes after school.
- Short-sightedness. People give more weight to today than tomorrow.
- Hard-to-judge facts. Few people can judge the medical risk of a vaccine or the addictiveness of a drug.
- Habits and addiction make people keep buying even when they know the harm.
Some economists add a second reason: externalities. Your vaccination also protects others (positive). Your smoking harms others nearby (negative). So the social value of the good differs from the private value.
Value judgement warning
Calling a good "merit" or "demerit" involves a value judgement (a normative view). Different societies may disagree, for example about alcohol or gambling.
How governments correct them
| Merit goods (raise use) | Demerit goods (cut use) |
|---|---|
| Subsidies that lower the price | Indirect taxes that raise the price |
| Free state provision (schools, vaccines) | Bans or age limits (no sales under 18) |
| Laws that require use (helmets, school attendance) | Rules on advertising and where it can be used |
| Information campaigns | Health warnings and campaigns |
Limits: taxes on demerit goods with inelastic demand cut use only a little and may hit poor people hardest. Bans can create illegal markets. Subsidies cost tax money. Information campaigns may be ignored.
Try it
Look at 10 products in your home or a shop. Sort them into merit, demerit or neither. For each merit or demerit good, write what information people might be missing, and one government policy that would help.
Key formulas and definitions
- Merit good: actual use < socially best use (under-consumed)
- Demerit good: actual use > socially best use (over-consumed)
- Main cause: information failure (and often externalities)
- Merit fixes: subsidy, free provision, compulsion, information
- Demerit fixes: tax, ban/age limit, regulation, warnings
Worked examples
1. Why is education a merit good? Use information failure.
Young people and families may not see how much more they will earn and how much better their health will be after more education. The reward comes years later. So they choose less than is best. Educated people also help others (lower crime, more skilled workers), an external benefit.
2. A city taxes sugary drinks by 20%. Sales fall from 1 000 to 900 cans a day. What does this tell you?
Sales fell by 10% after a 20% price rise, so demand is price inelastic (−10 ÷ 20 = −0.5). The tax cuts consumption only a little, but it raises revenue that could pay for health education.
3. Why might a ban on a demerit good fail?
If demand stays strong, an illegal (black) market may supply it. Quality is not checked, criminals earn the profit, and the state loses tax income. Enforcement is costly. So many governments prefer taxes, age limits and information.
Common mistakes
- Calling a merit good a public good. Education is rival and excludable; it is a merit good, not a public good.
- Saying demerit goods have no benefit. People enjoy them; the problem is that they over-value them.
- Forgetting the information failure. The key point is that people's view of the good differs from its true value.
- Assuming taxes on demerit goods always work. With inelastic demand, use falls only a little.