Merit goods

Merit goods provide external benefits when they are consumed.

For example, being educated not only provides the individual with private benefits such as higher wages and increased employability, it also provides a benefit to others. Well educated and trained workers pay more tax, and may become teachers or doctors, or may eventually become employers, all benefitting others and helping the economy.

If we add the external to the private benefit, we get the ‘social’ marginal benefit.

The recent Covid-19 crisis shows clearly that actions taken by indviduals not only benefit them but also benefit others. For example, social distancing measures and even simple hand-washing strategies provide protection for the individual and also other individuals who are less likely to become infected through contact with them.

Graphically, while this suggests more should be consumed, individuals are unlikely to understand the full benefit of merit goods – a phenomenon called ‘information failure’.

Social efficiency will occur at the output where marginal social benefit equals marginal social cost (at QS). But markets fail by only providing output Q, and the welfare loss is area A,B,C.

Merit goods
Video on merit and demerit goods

So, what can be done? Several options are available, including subsidising merit goods to increase output to QS. In this case, the subsidy per unit would be ‘b’ to ‘d’.

Legislation

It is also possible to introduce legislation to change behaviour and to penalise individuals who do not change their behaviour. Again, the Covid-19 pandemic provides a clear example of where legislation may be necessary, including enforcing 'lockdowns' and social distancing.

Nudge theory

Legislation may be supported by small 'nudges' to encourage people to change their behaviour. In the Covid-19 crisis many governments provided information regarding the number of people who did abide by the rules. 'Nudge theory' has become an increasingly significant contributor to understanding behaviour and to developing policies to change behaviour. Individuals can be 'nudged' towards making choices that generate increases in welfare for themselves and others.


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