Market failure resulting from the undersupply of merit goods

Key terms:

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.

© Mark Johnson,
InThinking www.thinkib.net/Economics 1
Activities

1. Watch the following short video and then answer the following questions:

(a) What is a merit good?

(b) Identify 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?

© Mark Johnson,
InThinking www.thinkib.net/Economics 2
Activity 3: Education

The diagram to the right 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.

© Mark Johnson,
InThinking www.thinkib.net/Economics 3
Activity 5: The clean energy market

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 as a group
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
Schools
University education
Public transport
Food stamps for low
income families
Subsidized housing
Pensions / out of
work benefits

© Mark Johnson,
InThinking www.thinkib.net/Economics 4
Activity 7

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
Medical services
Defence
Fire service
Public transport
National parks and
beaches
Public housing
Street lighting

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.

© Mark Johnson,
InThinking www.thinkib.net/Economics 5
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?

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 use to
increase the consumption of merit goods, e.g.

(a) Describe the internal and external benefits of receiving a university education. [10 marks]

(b) Using real life examples, evaluate the policies a government might use to increase
the number of young people receiving a university education. [15 marks]

© Mark Johnson,
InThinking www.thinkib.net/Economics 6