Demerit Goods

Article byAswathi Jayachandran
Reviewed byDheeraj Vaidya, CFA, FRM

Demerit Goods Definition

A demerit good is a good or service considered unhealthy, degrading, or socially improper. It is perceived as unfavorable due to its bad effects on consumers and society. The purpose of demerit goods is to address market imperfections and negative consequences associated with their consumption.

Demerit Goods

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They are distinct from standard goods, which are usually beneficial. Moreover, consuming these goods can have negative effects, so the government may discourage them through rules, public education initiatives, or high taxes. Societies seek to safeguard public health, lower societal expenses, and advance general well-being by identifying and categorizing these goods.

Key Takeaways

  • Demerit goods are products or services that negatively affect individuals or society, such as health risks, addiction, or environmental damage. Merit goods, on the other hand, are goods that society should have more and is beneficial to them.
  • Governments implement regulations to discourage consumption to protect public health, reduce social costs, and promote well-being. Governments often impose heavy taxation on demerit goods in order to discourage consumption, mitigate negative externalities and fund public health initiatives.
  • These goods exhibit negative externalities, inelastic demand, and information asymmetry between producers and consumers.

Demerit Goods Explained

Demerit goods are socially undesirable goods likely to be over-produced and consumed through the market mechanism. Hence, consuming these products may result in negative externalities not included in market prices. Moreover, individuals or society consider people over-consuming these goods or consuming them to an extent that is not in their best interest.

Consumers may need help understanding the risks involved with consuming these goods. A common strategy for changing these purchasing habits and advancing society’s general well-being is government action. These actions often address this knowledge gap by highlighting the potential harm and reducing use. Hence, promoting the use of merit goods could also accomplish this, as merit and demerit goods differ.

Hence, recognizing the potential harm associated with demerit goods consumption, governments and policymakers often implement interventions to protect consumers and society. These interventions include taxation, regulation, public awareness campaigns, and subsidies for healthier alternatives. Therefore, the aim is to encourage more responsible consumption choices and reduce the negative externalities associated with demerit goods.

Demerit goods diagrams or graphs are an easy way to understand the connection. The demerit goods diagram or graph can be showcased by plotting negative externalities in consumption and welfare.

Demerit Goods Graph

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The figure shows how the market needs to improve when dealing with inferior items. At a market price of O.P., consumers consume the demerit good in OQ quantities where demand (private marginal benefit) equals supply (private marginal cost). The social marginal cost, which represents the marginal external cost, is higher at OQ than the price by the vertical distance X.Y. At OQ1, where price = social marginal cost + social marginal benefit, a lower level of consumption would be necessary for social optimality.

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Characteristics

Demerit goods possess several distinguishing characteristics such as:

#1 – Negative Externalities

Negative externalities, which are spillover costs imposed on third parties not directly involved in the consumption or production of the good, are associated with demerit goods. For instance, when someone smokes, the secondhand smoke affects the health of others nearby, creating a negative externality.

#2 – Inelastic Demand

These goods have a limited change in demand when their prices fluctuate. Thus, consumers may have formed habits around these goods, may be addicted to them, or may not have viable alternatives.

#3 – Lack Of Information

There is often a difference in the information available to producers and consumers of demerit goods. Consumers may need to be aware of the risks associated with these goods, which can lead to them making less-than-optimal decisions.

#4 – Overconsumption

Due to the immediate gratification or pleasure associated with demerit goods, individuals often consume them in excessive quantities. This overconsumption can lead to various negative consequences, such as health problems, addiction, and social costs.

#5 – Short-Term Benefits, Long-Term Costs

These goods often provide short-term benefits or pleasures but can result in long-term costs and harm. For example, fast food may taste good and be convenient in the short term, but excessive consumption can lead to obesity and related health issues over time.

Examples

Let us check out these examples to get a better idea:

Example #1

Let’s consider the example of Dan, a consumer of demerit goods, i.e., cigarettes.

As a smoker, Dan acknowledges the harmful effects of smoking, including lung cancer, heart disease, and respiratory problems. He struggles to quit due to the addictive nature of cigarettes despite his knowledge of its negative effects. Moreover, governments impose heavy taxes on demerit goods like cigarettes to discourage consumption and mitigate negative externalities.

These taxes increase the price of cigarettes, making them less affordable and reducing demand. These constraints also protect the lives of people who do not smoke but are exposed to it. The revenue generated can fund public health initiatives, anti-smoking campaigns, and healthcare programs. Additionally, taxes are a deterrent, especially for price-sensitive consumers, by making smoking a more expensive habit. Through such regulations, the government tries to reduce the menace caused by the consumption of these goods.

Example #2

A typical real-life demerit good example is alcoholic beverages. Drinking alcohol can have various detrimental effects, such as health issues, impaired judgment, addiction, and social concerns. Hence, In Scotland, a minimum alcohol price was implemented in 2018 to reduce the drinking problem.

A four-pack of cider might cost 10% more, while a pack of 20 cans might treble since Scotland will no longer allow the sale of alcohol for less than 50p per unit. Wales is considering taking similar action.

The U.K. government announced the legislation on April 6, 2018, asking customers to pay an extra 18p or 24p per liter for sugary drinks, depending on the amount of sugar added.

Taxation

Excise taxes are levied on demerit goods in the United States, such as cigarettes, alcohol, and sugary beverages, to reduce consumption and address social costs. Countries across the globe have their regulations or levy different indirect taxes on demerit goods. Moreover, the federal government of the U.S. imposes a fixed excise tax per pack, while states may impose additional taxes.

Furthermore, this taxation helps internalize the external costs associated with demerit goods. Negative externalities, such as health care expenses related to smoking or the social costs of alcohol abuse, are partly paid for through the higher tariffs imposed on these goods. Besides discouraging consumption, taxation generates significant revenue for the government. Hence, this revenue can be used for various purposes, such as funding healthcare programs, public awareness campaigns, or subsidies for healthier alternatives.

Thus, policymakers must balance discouraging consumption and ensuring excessive taxation does not lead to black markets or unintended consequences.

Frequently Asked Questions (FAQs)

1. Are demerit goods public goods?

No, these goods are not public goods. Negative consequences characterize demerit goods and are typically overconsumed, necessitating government intervention to correct market failures. On the other hand, public goods have unique characteristics related to non-excludability and non-rivalry and are often provided or regulated by the government due to their public nature.

2. Are demerit goods excludable?

Demerit products are generally excludable because access to them can be constrained by putting restrictions in place or requiring payment. Excludability means that access to demerit products can be restricted, and their consumption is often limited to those who pay for them.

3. Why are demerit goods a market failure?

These goods can lead to market failure due to negative externalities, such as increased healthcare costs or environmental damage. Hence, these externalities distort the market, leading to an inefficient allocation of resources and underestimation of actual social costs, ultimately causing market failure.

4. Why are demerit goods produced?

They are produced to meet demand, driven by addiction, habit formation, and lack of risk awareness. Producers meet this demand to generate profit. However, overproduction can occur due to incomplete information, addictive qualities, or lack of substitutes, leading to negative externalities and market inefficiencies.

This article has been a guide to Demerit Goods and its definition. Here, we explain it with its examples, characteristics, and taxation. You may also find some useful articles here –

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