JC Econs Essay Demerit Goods & Public Goods Model Answers
While most of you understand what demerit goods, sometimes you do not get to explain how it leads an over-consumption of such goods, as a form of negative externality. Yes, in fact, depending on the question, you may need to explain it as an excludable and rival good instead.
That means, you have to compare with a public good. Hence, do prepare your preferred choice of a public goods, including national defence, policing services, public warning systems, and street lighting, etc. Public goods that are both non-excludable and non-rival, do remember that public goods are essentially an inefficiency issue in consumption, hence we say non-excludable in consumption, and also non-rival in consumption.
Question
(a) Explain how demerit goods are different from public goods.
(b) Discuss the policies that a government might use to achieve a more efficient allocation of resources where demerit goods exist in markets.
JC Econs Essay – Demerit Goods vs Public Goods
Suggested Answer: Part (a)
Define public goods: Goods that exhibit the characteristics of non-excludability and non- rivalry.
Demerit goods: deemed socially undesirable by the government
| Demerit Good | Public Good | |
| Externality |
➜socially undesirable good ➜ imposes cost to society more than the cost to individual consumers ➜ ie. there are external costs (negative externalities) Example: smoking and junk food harm the individuals who receive them, but there are also costs to society, say from having a less than healthy workforce |
High positive externalities where the social benefit is far greater than the private benefit Example: street lighting, national defence, lighthouse and flood control. |
| Excludability |
Private goods excludability and rivalry in consumption. Owners of demerit goods: → can exercise private property rights i.e can prevent others from consuming its or using it private benefits. Example: A person who is not willing to pay can be excluded from consuming the cigarette. It is therefore not prohibitively costly to confine the private benefits to a selected group of people. |
No effective way of excluding anyone who walks the street at night from benefiting from it. → impossible, or prohibitively costly to confine the benefits of the good once produced to selected persons. Provision of a public good to any one person automatically makes it available to others, so NON-excludable |
| Rivalry |
Demerit good is rivalry in consumption. When one person consumes it, less of the benefits are available to other people. The benefits derived goes to a particular consumer and consumption by him excludes consumption by others. Example: When someone drinks one-third of a can of coke, only two-third remain. Benefits are internalised and consumption is rival. |
NON-rival. (consumption of the street lighting services by one individual does not reduce amount of the street lighting services by others. Equally bright for all.) Therefore, for street lighting, if lights are provided, they shine on everyone. Another example :National defence. Once an armed force is built, the same amount of protection to the citizens will not be reduced when there are new citizens. There is no opportunity cost of consumption of such a good. |
| Allocation of resources |
Over allocation of resources if left to private market |
No allocation of resources if left to private market |
| Provision |
Excludability & Rivalry in consumption: → demerit goods can be profitably produced by private sector. ‘Exclusion principle’ →makes goods marketable (because C is ‘rival’ so that exclusion may be applied) Market mechanism functions only If the exclusion principle applies, i.e. if A’s consumption is made by his paying the price, so, B who does not pay is excluded. Market is based on exchange, and exchange cannot occur without there being an exclusive title to the property which is to be exchanged. If demerit goods are provided through the free market, excessive level of the goods would be consumed. Price mechanism under allocates resources for the demerit goods because individual consumers do not take into account the -VE externalities arising from the consumption of such goods. G intervenes so demerit goods consumed by private individuals would fall. |
Public good is non-rival in consumption, ie MC of serving an additional user is zero. Socially optimal output where P = MC. To be allocative efficiency →public good provided free by G (impossible for private to produce ) Non-excludability of public good → free-rider problem arises. If C is not made by payment, consumers will not voluntarily offer payments to the suppliers of the public goods. Each will find it in his interest to share in the provision made by others as a “free rider”. If all consumers act in this fashion, →no effective DD for the gds. →PM breaks down (No allocation) Producers are given no signals about what to produce and there is no one to whom they can sell. A classic example is that of a lighthouse. When the light is on, it is difficult to prevent any nearby ship from seeing it and taking advantage of it. So G provides public goods finance production using tax at zero price
(Note: Certain public goods need not necessarily be provided by the government. Eg lighthouses can be provided by the maritime industry as a social project. |
(Qn: Are the above areas of comparison the best ones? How to improve the areas of distinction?)
Alternatively, as for comparing the differences between public and merit goods, the following distinction is fine:
| Merit Good | Public Good | |
| private good with +VE EXT | +VE EXT | |
| Characteristic 1: Excludability |
Excludable: Possible to exclude others from using it once it is provided. Possible to assign property rights to only those who pay for it.
|
Non-excludable: Impossible to exclude others from using it Collectively consumed so not possible to assign property rights to only those who pay for it. >Free-rider problem. |
| Characteristic 2: Rivalry |
Rivalry: The consumption of the private good by one person will diminish another person’s ability to consume the same good. >Once the good is produced, the additional resource cost to provide for another person so that he can benefit from consuming the good is not zero. MC is not zero. |
Non-rival: The consumption of the public good by one person will not diminish another person’s ability to consume the same. good. Once the good is produced, the additional resource cost to provide for another person so that he can benefit from consuming the good is zero. MC=0. |
| Characteristic 3: Provision |
Provided by private producers & public Merit goods can be profitably produced by private sector. Since MC is not zero, when producer ensures allocative efficiency, he will set price at P = MC. MC of firm will rise with each additional unit produced so producers will face an upward sloping curve. But under allocation of resources due to the positive externalities, G intervenes. |
Public provision Public goods cannot be profitably produced by private sector Since MC = 0 and allocative efficiency states that P = MC, private producers will have to provide such goods for free. MC = 0 so P=0 However, since private producers are always profit maximisers, they will not produce the public good at all. Since consumers can free-ride, they will be no effective demand curve because they have no willingness to pay. (only ability) The lack of both demand and supply curves is a cause for government intervention. So, public goods are usually provided by the government. There are times when public goods are provided by private firms. Eg lighthouses can be provided by the maritime industry as a social project. |
Brief Mark Scheme for Market Failure Essays:
L3: Thorough distinction between public and merit goods that goes 8-10 beyond excludability and rivalry features. Examples given.
L2: For an undeveloped explanation that explains the concepts without appropriate examples. Main distinction based excludability and non rivalry. on
L1: For an answer which shows some knowledge of the concepts. Definition of merit and public goods.
JC Econs Essay – Micro Economics Policies To Address merit Good
Aims Of G:
1. ensure equity (poor not deprived/ affordable prices)
2. maximize consumer welfare
3. ensure an efficient allocation of resources
What is efficient allocation of resources:
Efficient resource allocation where MSB=MSC benefit derived from additional unit of product =cost of producing it →maximum society welfare
Explain whether there s efficient allocation of resources for merit goods.
Eg: Healthcare.
Explanation of divergence MSB & MPB due to positive externalities: A person takes into account his private benefits (of being healthy and ability to take part in economic and social activities). , but does not consider the positive externalities or external benefits that would be generated by his prevention of falling sick (reduce the risk of spreading infection to others) as well as the efficiency and productivity at work. Hence social benefit gained by the society is higher than the private benefit.
Eg: Explanation of divergence MSB & MPB due to positive externalities; use diagram(s), sketch tit on your won as an exercise: Explanation of private equilibrium & social equilibrium / allocation of resources/C welfare: use resources / correct or address positive externalities:
(Also, can explain imperfect information for merit goods)
Explanation of private market eqm & social eqm /allocation of resources/C welfare:
Private individuals consume at level OQe where its MPC = MPB Socially efficient level of consumption should be at OQs where MSC = MSB. There is an under-consumption of the good. Net economic welfare to the society is not maximised as there is a welfare loss equal to the shaded triangle.
Hence, G intervenes to increase C to the socially efficient level of OQs.
What policies can G use to achieve efficient allocation of resources / correct positive externalities:
(Explanation of how it corrects positive externalities and/ or information failure.)
Policy 1: Subsidies
Gov gives a subsidy equal to the external marginal benefit, then it will force the firm to effectively internalize the externality. Producers will be encouraged to produce more and the supply curve will shift to the right to PMC + subsidy (refer to figure 2).
The socially efficient level of output OQs will thus be achieved.
(In the same diagram, the SS curve shifts downwards.)
Limitations:
Subsidising a merit good is especially important in ensuring that the poor are not deprived of consuming a sufficient amount of the socially desirable goods. This serves the aim of government in ensuring equity. More people are able to enjoy the merit goods at affordable prices. This leads to improvement in people’s well being.
However, G in granting subsidies performs the role of a re-distributor, using tax revenue collected to finance the provision of merit goods, a key necessity for the poor. →But G expenditure in other areas has to be reduced or tax rates may have to be increased. It is also difficult to assess the monetary value of the external benefits and hence estimate the right amount of subsidy, especially for different groups of citizens and thus results in equity issues.
[Spore Context]:
Means Testing & Co-payment:
In Singapore, the level of subsidy is given based on the income levels and system of co-payments, ensuring greater equity and more efficient allocation of resources. Hence, G needs to ensure a level of subsidy that encourages greater consumption, yet not create a welfare state where individuals rely on the state for provision of merit goods.
Policy 2:
Another way to ensure that consumption of the merit good is at the socially efficient level is by public provision to complement the private producers.
Referring to figure 2, while the private sector produces OQe, government will produce QeQs. G provide these goods at a subsidized rate or at zero cost.
[Spore Context]:
Singapore government to make healthcare more accessible to people, G operates mobile clinics and have polyclinics in major housing estates. Medical services are also available at restructured hospitals at subsidized rates,
Limitations:
Gov participation, so greater competition in the mkt hence greater variety and better quality for the consumers. However increase G expenditure (funds raised through taxes) less for other areas like education etc.
If G raise taxes to finance, this may produce disincentive to work Providing merit good at zero price→ lead to wastage or excessive C beyond what is socially efficient.
Policy 3
A third measure that can be adopted is legislation and regulation. Legislation can be passed to make it compulsory for the consumption amount of a certain amount of merit goods.
[S’pore Context]:
For example, in SG, primary school education is compulsory for all and there is also compulsory vaccination for children and health screening for workers.
Limitations: Legislations are simple and clear to understand relatively easy to administer more people complying →result in better well-being for the population affect economy positively in the future. However, too blunt and harsh, almost ignoring consumers’ tastes and preferences.
For the law to be effective:
Penalties for breaking the law should be made sufficiently harsh Inspections made more frequent →This increase cost for G both for providing free merit goods and to ensure that people comply with the law.
[Spore Context]:
Implementation of legislation with regards to compulsory consumption of merit goods has been appropriate in Singapore as there are systems to track those who are not doing so. This helps to ensure the consumption of the merit goods at least at the basic level.
Conclusion:
Hence, with joint provision and the implementation of subsidies a higher level of consumption may result. However, these also have their limitations as lower prices need not guarantee greater consumption of a merit good.
For example, the ability to continue education at a higher level does not depend on price alone. Grades and personal ambition also determines the socially optimal level of education consumed.
Therefore, a combination of policies is needed to bring about a more efficient allocation of resources. There has to be a slew of both short run measures (provision of adequate healthcare services, subsidies) and long term strategies to solve the root of the problem. Long term strategies will include using moral suasion through public education. Having public campaigns to create awareness of the importance of consuming merit goods like the healthy lifestyle campaign. Such public education aims to change the mindset of people and hence requires time.
In conclusion, we need to understand that government intervention involves certain costs. In some circumstances, government interventions may fail to improve on, or even worsen, the situation in the markets. Whether the government should intervene or not will depend on the magnitude of the market failures and the social costs and social benefits of the government intervention.
Marking Scheme
L3: For a thorough analysis of how at least 2 policies help to attain the efficient allocation of resources using diagram and examples. Competent explanation of market failure. Only 2 policies: max. 9m.
L2: For an under-developed explanation of how at least 2 policies help to 5-8 attain efficient allocation of resources, with some illustrations, either diagram or examples. Undeveloped explanation of market failure. Correct or unexplained diagram. OR 1 developed policy but other policies are undeveloped.
L1: For a general and superficial answer which shows some knowledge 1-4 of policies or positive externality as a source of market failure or undeveloped explanation of 1 policy.
Evaluation
E2: For an evaluative discussion based on economic analysis.
E1: For an unexplained judgement, or one that is not supported by economic analysis.
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