M/J 2013 P21 Q2

Merit goods are socially desirable goods that produce large positive externalities, where the
Marginal Social Benefit is greater than the Marginal Private Benefit. Examples of merit goods are
education and healthcare. In a free market economy, merit goods are often expensive and under
consumed.
*insert positive externality graph from consumption of merit good*

For example, a doctor who pursues his studies in medicine would have to spend a large amount of
money on his tuition fees, resulting in the MPC lying above the MSC. The point at which the MPC
cuts the MPB is the market price and quantity demanded of the good in the market. The point at
which the MSC cuts the MSB (assuming MSB=MPB) is the socially optimum price and quantity
demanded. For merit goods, the market price is higher than the socially optimum price, and this
results in the under consumption of merit goods. In this case, free markets are ineffective at arriving
at the correct price as the cost does not reflect all the benefits of consumption. Government
intervention is needed to ensure the ‘correct price’ of the merit goods.

Demerit goods are goods that exhibit very large negative externalities, where the MSC is greater
than the MPC. Examples of demerit goods are alcohol and cigarettes. Demerit goods are often over
produced and over consumed.

*insert graph*

For example, a person who is sad may decide to head to a bar for a few drinks. He pays RM 100 in
total for the drinks. He then gets drunk and is irresponsible enough to still insist on driving home.
Unfortunately, he accidentally runs over a pedestrian. He has resulted in a negative externality.
Therefore for demerit goods, the MSC lies above the MPC. The market price lies below the socially
optimum price and there is an over consumption of QsoQe. Government intervention, eg imposing
heavy taxes, is needed to correct the price of a demerit good to reflect the true cost (taking into
account the negative externalities) of a good.
Merit Good

Subsidy

The aim of a subsidy is to reduce the MPC of consuming a good. A subsidy would

Demerit Good

Indirect tax