Demerit goods

Demerit goods, such as alcohol, provide less benefit than is perceived by consumers – as with many goods, there is a problem of ‘information failure’.

Here, the negative external benefit from marginal consumption shifts the social marginal benefit curve to the left.

The socially efficient level of consumption is at QS, but markets would over-supply them, at Q, as markets only take into account the perceived private benefits (and costs). Here we assume there is no external cost of production, only consumption – though this may not be true. The welfare loss is ‘a’, ‘b’, ‘c’.

Demerit goods

Remedies

Several remedies exist, including taxation of demerit goods, and imposing minimum prices.

The effect of a tax is to internalise the externality, so that consumers (and producers) bear some of the external cost. Demand contracts from a to e, and the socially efficient output at Qs can be established.

Demerit goods

A minimum price can also be established, which forces sellers and retailers to charge this price. Again, demand contracts and the socially efficient output is established.

Demerit goods

Video on merit and demerit goods

In both cases there is the criticism that government intervention might not achieve the socially optimal solution.

Information failure can distort the decision making process so that imposing a special alcohol tax of 20%, for example, might not be sufficient, or it may prove excessive. Also, the law of unintended consequences may weaken the overall effectiveness of the intervention - for example, taxes may drive consumption into the 'hidden' or 'shadow' economy, with little effect on consumption, but resulting in a fall in government revenue.

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