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Demerit goods

Author: Geoff Riley  Last updated: Sunday 23 September, 2012

Introduction

Demerit goods

Market failure with demerit goods

The free market may fail to take into account the negative externalities of consumption because the social cost exceeds the private cost. Consumers too may experience imperfect information about the long term costs to themselves of consuming products deemed to be de-merit goods

Obesity – a time bomb

There is a huge debate at the moment about the root causes of obesity and the social costs that arise from increasing levels of obesity. Obesity is also an international problem. Across the Atlantic in the USA, two out of every three Americans are overweight; one out of every three is obese. One in three is expected to have diabetes by 2050. Minorities have been even more profoundly affected.

What of harder drugs?

Should hard drugs be prohibited at all costs by the government in a bid to control demand by restricting supply? Regulation has been the route chosen by most governments in developed countries – but economists are divided on the issue. Some believe that legalisation and taxation of harder class drugs is a better policy to pursue, arguing that regulation is ineffective and costly. Another approach would be to divert resources away from regulation towards giving better information to drug users about the longer term health implications of their consumption decisions.

The case for a complete ban

The case for a complete ban on de-merit goods such as class A narcotics could be justified on the ground that the social marginal cost of consumption is always higher than the social marginal benefit. In the diagram above there is no output where the social benefit equals the social cost and welfare would be best protected by trying to enforce a total ban on the product.

Food additives – a de-merit good?

  • The use of food additives has long been a subject of controversy.
  • Examples include the preservatives used in products from soft drinks to barbecue sauce – designed to lengthen the shelf life of products available for sale in supermarkets.
  • Research published in 2007 by the Food Standards Agency claimed a link between food additives and hyperactive behaviour in children leading to losses of concentration and a worsening in behaviour ands they want a number of food colourings to be banned.

Gambling – economic and social effects

From betting on the results of general elections, the Grand National, the number of corners that England win in one of their World Cup matches or the temperature in London on Christmas Day, we seem to have an almost insatiable desire for gambling on the outcomes of virtually every sporting, political, meteorological event.

Inevitably the rapid expansion of this industry raises important questions about the external costs and benefits of gambling. Some researchers point to the employment and tourism benefits that flow from the growth in demand for gambling services especially if businesses are established in some of the UK's poorest towns and cities. There is also a fiscal dividend from this booming industry with a predicted £3bn per year of extra tax revenues flowing into the Treasury's coffers.

But gambling also creates external costs. Over 350,000 people in the UK are thought to be addicted to betting and their problem gambling can contribute to crises including personal debt or bankruptcy, loss of employment and the breakdown of families. The dangers of addiction are greatest for the young and the vulnerable susceptible to advertising and marketing strategies.

The usual approach to de-merit goods is to tax consumption, so that the private cost of consumption is increased and demand contracts. But the government has actually got rid of betting & gaming duty (it was abolished in 2001) to be replaced with a tax on the profits of gaming companies. The Gambling Act of 2005 deregulates the industry and allows the creation of more casinos in the UK.

Three Examples:

Mephedrone ban – intervening to regulate a demerit good

The UK government has announced a ban on mephedrone. Behind the reason to classify this drug as a demerit good includes the informational failures that exist - “It is being taken by young people who have never taken drugs before in their lives because they think it is legal and it is safe. It is neither legal nor safe.” David Nutt, ex-head of Advisory Council on the Misuse of Drugs, discusses in this article in the Guardian why regulation rather than an outright ban should be implemented instead. (March 2010)

 

Credit card cheques as a demerit good

The government has announced a move to ban credit card cheques addressing the issue of the soaring value of UK consumer debt.  The move is part of a broader range of measures that attempts to partly bridge the informational failures (and resultant market failure) that lead to consumers inadvertently taking on debt that is beyond their means; and this recent measure highlights the government’s view on it as a demerit good. (July 2009)

 

External costs of alcohol abuse
The number of alcohol-related hospital admissions in England has topped one million for the first time. An NHS Information Centre report said admissions had increased by 12% between 2008-09 and 2009-10. That includes liver disease and mental disorders due to alcohol abuse as well as some cancers, accidents and injuries. The government is taking steps to address the problem including plans to stop supermarkets selling below cost alcohol and introducing tougher licensing regimes for pubs and clubs.





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