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Merit Goods
Merit goods are goods that the government believes consumers will buy too few units if
provided by the market because of information failure (under-estimation of the private
benefits in consumption) and positive externalities in consumption (benefits on third parties
not considered).
Examples of merit goods include education and healthcare.
In the case of education, individuals who make decisions about how much education to receive
do not fully appreciate the private benefits that will be received through being educated. For
example, education increases the productivity of individuals and raises their salaries over their
working lives. However, the increases in income are in the future, uncertain and difficult to
estimate accurately. This lack of information leads people to underestimate the private
benefits of education.
With full information, consumers will be better informed and more able to appreciate the full
benefits from consuming the good. Hence, they are more willing to purchase the product. Since
the demand curve reflects the willingness and ability to buy the goods, the qty demanded at
every price level increases, hence dd curve would be at DD2.This would lead to a level of
production and consumption of OQ2, the socially efficient quantity of the good.
However because consumers undervalue the private benefits of the good, demand
registered in the market is less than when there is full information. At every price level, the
quantity demanded falls and hence dd curve shifts to DD1 as the consumers are less willing to
consume the good as compared to the case of perfect information. This leads to a level of
production and consumption of OQ1. This is below the socially efficient output level, OQ2 and
the market has failed to allocate resources efficiently. There is an under-production and
under-consumption of Q1Q2 of the good which results in a deadweight loss equal to the area
E2BE1.
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Evaluation:
Consumption of merit goods like education also generates positive externalities. With more
education, workers are equipped with better skills and hence likely to have higher productivity,
producing more output/man hour. The increase in quality of workers increases the productive
capacity of the economy, leading to potential growth for the economy. As individuals are only
concerned about their private benefits and costs when making decisions, they ignore such
external benefits to society, worsening the extent of the under-consumption problem, worsening
the market failure.
[Use the presence of externalities as an evaluation exacerbates the market failure]










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Public Goods
Public goods are goods that exhibit characteristics of non-excludability and non-rivalry in
consumption.
The feature of non-excludability of public good means those non-paying consumers can
benefit without having to pay for it. E.g. once the traffic light is set up, everyone is free to use.
It is almost impossible to exclude anyone from using it.
The property of non-excludability give rise to the free rider problem - where it is possible for a
person to consume a public good without having to pay for it. From the demand side of the
market, the desire to be a free rider weakens the incentive for consumers to offer to pay for
public goods - no consumer will reveal his demand for the good. Since there is no expression
of demand, signaling function of the price mechanism fails hence it is impossible to
determine a market price for the good. If such goods were to be left to the private market, they
would not be provided at all.
The feature of non-rivalry means that the consumption of the good by one user will not
diminish another persons ability to consume the good. The usage of traffic lights by one
pedestrian will not affect the usage of the traffic lights by other users.
The property of non-rivalry also means the opportunity cost of admitting one more user of the
good is zero and hence, assuming no externalities, the additional cost to society of producing
this extra unit =0 MSC=0. At the social optimum level of output, the additional benefits to
society equals to the additional costs to society of producing the good. This occurs at
MSB = MSC where societys welfare is maximized. Hence, the socially ideal price will be zero.
With 0 market price, the good will not be provided by the private sector at all as they would not
be able to earn any profits from the provision of the good. Hence none will be supplied by the
market since producers are profit motivated.
Public goods tend to be provided by the govt as no firms will undertake the production due to
their characteristics of non-rivalry and non-excludability.

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