Unit 2.8: Merit goods
This lesson looks at another reason for market failure in economics - the under supply of merit goods in an economy. I find that students will sometimes confuse the concepts of merit goods and positive externalities. It is important to make the distinction that merit goods are goods or services which consumers will often undervalue, but which provide positive externalities to third parties when consumed. Positive externalities can be described as benefits enjoyed by a third-party when a consumer makes a purchasing decision. Examples include health or education services.
The lesson also focuses on how governments can correct market failure, by the implementation of subsidies on those goods and services. Your students need to be given the opportunity to practice drawing each of the diagrams on market failure - so they become proficient in illustrating the benefits of government action to correct market failure. Market failure is a common question on the paper one examination and any response must include a suitable diagram. It is my experience that students find it difficult to draw market failure diagrams.
Enquiry questionWhy might the provision of some goods e.g. health and education services be under provided by the market. What measures can a government take to ensure an adequate production of merit goods are provided within any society.
Lesson time: 90 minutes
Explain, using diagrams and examples, the concepts of positive externalities of production and consumption, and the welfare loss associated with the production or consumption of a good or service.
Explain that merit goods are goods whose consumption creates external benefits.
Evaluate, using diagrams, the use of government responses, including subsidies, legislation, advertising to influence behaviour, and direct provision of goods and services.
1. Governments will collect tax revenue to fund essential public services. Which public service(s) do you think offer the best return for governments in terms of their impact in the growth of GDP?
2. Should governments provide merit goods such as public transport, health and education free of charge at the point of sale? Consider the opportunity costs of such a decision.
Merit goods - goods or services with strong positive externalities. Merit goods would be under-provided by the market and so under-consumed.
Positive externalities - benefits enjoyed by a third-party when a consumer makes a purchasing decision.
Marginal private benefit - the private benefit (utility) enjoyed by a household (or business) in actually consuming (or producing) a good.
Marginal social benefit − this is equal to marginal private benefit (MPB) + the externalities of consumption or production.
Social efficiency - this occurs when the resources in an economy are used in the most efficient way possible and are represented by the output level where the social marginal costs = the social marginal benefits of production.
The activities on this page are available as a PDF file at: Merit goods
Watch the following short video and then answer the following questions:
(a) What is a merit good?
(b) Identify some examples from the video of goods that provide obvious positive benefits to any society.
(c) Why are many merit goods under demanded (relative to the social optimum level of production), in free market systems?
(d) What other reasons does the video give to explain why many merit goods are provided by governments?
(e) Outline a criticism of merit good provision by governments.
Activity 2: Applying the theory to Flu vaccinations
Watch the following short video and then answer the two questions that follow:
(a) What are the spillover costs associated with flu shots?
(b) why does this represent a market failure in free market systems?
Activity 3: Education
The diagram to the left illustrates the market for a merit good, education in a free market.
(a) What are the private benefits of a university education?
(b) What are the social benefits to society of university education?
(c) In a free market how many students will enter university and what level of tuition would be charged?
(d) What is the socially optimum level of students receiving a university education?
Activity 4: Providing a subsidy to correct market failure
In an effort to correct market failure many governments will provide education either free of charge or heavily subsidized.
(a) Redraw diagram 1 showing the size of the subsidy and the new equilibrium level of students and tuition fee.
(b) Outline disadvantages of the policy.
Activity 5: The market for clean energy
The following table represents the current cost of generating electricity in the USA, if left up to the free market.
Use this diagram to explain whether governments should intervene in the market for energy generation?
Activity 6: Group exercise
Imagine you are given the keys to the treasury of your government. Your first task is to decide which of the following public services you wish to provide free at the point of delivery, which to subsidize and which not to fund at all. Remember that every $ you spend on services must be collected out of taxation.
|Public service||Provide free||Subsidize||Don't fund|
|Medical care (emergency services)|
|Non essential medical care|
|Food stamps for low income families|
|Pensions / out of work benefits|
Complete the following table which includes some of the public services provided by many governments. Which can be considered public goods, which can be considered merit goods and which fulfil neither category?
|Public good||Private good||Merit good|
|Schools / university|
|National parks and beaches|
Activity 8: Public funded health care programmes
In USA most University and health services are paid for by the consumer at the point of sale. By contrast in most European countries those services are paid for out of general taxation. Discuss the merits of both American and European systems of providing those services after watching the following video:
Activity 9: Over crowded public services
Watch the following short video and then explain using a supply and demand curve why the provision of free public services is likely to lead to excess demand.
Activity 10: Links to TOK
(a) Given that all public goods are merit goods and that medical services are merit goods then surely all medical services are also public goods? Is this statement true and if not, why not?
(b) How can we calculate the external costs of producing and running items such as light bulbs or motor vehicles?
Activity 11: Link to the assessment
A typical paper one question may ask candidates to consider the benefits enjoyed by the consumption of merit goods and evaluate / discuss policies that a government could employ to increase the consumption of merit goods, e.g.
1. (a) Describe the internal and external benefits of receiving a university education. [10 marks]
(b) Using real world examples, evaluate the policies a government might use to increase the number of young people receiving a university education. [15 marks]
An essay template for the above question can be downloaded at: Section A essay template