Merit goods and services create positive externalities when consumed and these 3rd party spill over benefits can have a significant effect on social welfare. Market failure occurs when merit goods and services are under-consumed under free market conditions. Policy intervention can help either through offering financial incentives (e.g. consumer or producer subsidies) or through behavioural nudges and information campaigns designed to change our choices.

1. Market Failure – Merit Goods

2. Market Failure
Merit Goods

3. What are Merit Goods?
• Merit goods are goods and services that the government feels that
people will under-consume, and which ought to be subsidised or
provided free at the point of use.
• Both the state and the private sector provide merit goods.
• Consumption of merit goods is often argued to generate positive
externalities - where the social benefit from consumption exceeds
the private benefit.
• A merit good is a product that society values and judges that
people should have regardless of their ability to pay.
• With merit goods individuals may not act in their own interest
because of imperfect information – they do not fully understand
the private benefits of their consumption. Information failure is an
important aspect of the merit goods issue.
• Unlike pure public goods, merit goods can be rival, excludable and
rejectable.

4. Examples of Merit Goods
Health programmes Early years
education e.g.
nursery provision
Subsidised Bike
Schemes
Public libraries /
community spaces
Museums and
Galleries
Free school meals /
nutritional advice

5. Merit Goods, Externalities & Market Failure
Costs,
Benefits
£s
Output / quantity
MPC
P1
Q1
MPB
MSB
P2
Q2
One cause of under-
consumption is that people
will only consider their own
private costs and benefits –
leading to a private optimum
output of Q1.
If the consumption of merit
goods leads to external
benefits, the optimum
output from society’s point
of view is at Q2
P3
Welfare loss
arising from
under-
consumption
Merit goods give
rise to external
benefits

6. Merit Goods, Information Gaps & Market Failure
Costs,
Benefits
£s
Output / quantity
MPC
P1
Q1
MPB (limited
information)
P2
Q2
Another aspect of
merit goods is that
individuals may have
imperfect information
about their own
private benefits. If
they had better
information on the
benefits to
themselves of
consuming a good or
service, the marginal
private benefit curve
would shift outwards
leading to a higher
equilibrium quantity
MPB (fuller
information)
Market demand
would be higher if
consumers had better
information
Link merit goods
to information
failure

7. Education as a Merit Goods
• Parents may be unaware of the benefits their children get from
staying in full-time educations
• Education is a long-term investment decision. The private costs
must be paid now but private benefits (including higher earnings
potential over one’s working life) take many years to happen.
• Education provides external benefits including rising incomes
and productivity for current and future generations and an
increase in occupational mobility to help to reduce
unemployment.
• Increased spending on education can provide a stimulus for
higher-level research (which improves competitiveness) + a more
enlightened and cultured society.
• Judgements involve subjective opinions – we cannot escape from
making value judgements when we are discussing merit goods.

8. Economic Importance of Education & Health Spending
Education and health are regarded by economists as merit goods.
An increase in funding of both can affect the macro-economy
Education spending
• May increase the skills and productivity
of workers leading to lower unit costs
• Improvement in human capital will
lower structural unemployment
• More innovation / competitiveness
Health care spending
• Improved health boosts labour supply
• Will also increase productivity
• Lessens risks of relative poverty
• Long run – lower NHS costs / sick pay
Evaluation Arguments
1. Effectiveness of extra
education spending has
been questioned
2. Money might be better
spent targeting certain
groups or ages
Evaluation Arguments
1. Better health results can
be achieved without
increase in funding
2. Will lower income
families get improved
access to NHS care?

9. Health Care
Ageing
Population
Rising
expectations
Inequality and
NHS burden
Growing
population
High cost of new
treatments
Chronic illnesses
& conditions
There is strong pressure for rising health care spending in many
countries including the UK. Here are some causal factors:

10. Who Should Fund and Provide Health Care?
Should health care treatments be provided by the state free at the
point of need? Or should markets play a bigger role?
• Scale and Scope: Priorities:
• How important is health care to an economy?
• Might other areas of govt spending become more important
in the future requiring a shift of resources?
• Short run and Long-run:
• In the long run, can a “free” NHS be sustained?
• Equity / fairness:
• Many people see ‘free’ access to high quality health care as a
right, and a fundamental issue of ‘fairness’ or equity
• Alternatives:
• What are the alternative ways of providing health care?
• Strong evaluation draws from different countries

11. Health – The Case for State (Government) Health Care
State
Health
Care
(such
as the
NHS)
Helps to provide equality of access to
key healthcare resources not based on
people’s ability to pay
A state-funded service can provide
impartial advice and help helping to
avoid some information failures
By making health care cheap and
readily available it could promote
consumption thereby boosting GDP
Positive externalities – the merit good
aspect to affordable and widely
accessible health care.
A large provider of health care can
enjoy economies of scale – therefore
more efficient than the private sector
Percentage of public and
private health expenditure
in selected countries (2011)
% of GDP Public Private
UK 82 18
Japan 82 18
France 77 23
Germany 76 24
Spain 73 27
Turkey 73 27
Russia 60 40
China 56 44
Brazil 46 54
India 30 70

12. Health – The Case for Market-Provided Health Care
Private
Sector
Market-
Based
Health
Care
You don’t have queues or rationing in
markets. There might even be less
wasteful use of services.
The best health firms (hospitals)
should compete for excellence,
innovation, top staff and the best
procedures.
Providers should always be anxious
to cut costs and boost efficiency.
If people know that they are
responsible for paying for health
care, it might influence their lifestyle
choices.
Healthcare expenditure as a
share of GDP in the United
Kingdom 1997 to 2012 (%)
1997 6.5
2000 6.9
2003 7.8
2006 8.3
2009 9.7
2012 9.2

13. Alternative Funding of Health Care in the UK
With increasing pressure on state health budgets, a number of
alternative approaches have been suggested for the UK
Incentives to take
out private
insurance
A rise in
prescription
charges for basic
medicines
Private hotel-style
beds to raise extra
revenues
Basic annual NHS
subscription
system for all
More health
tourism in
overseas countries
Funding
preventative
programmes
Strong critical
evaluation in
micro exams
includes
assessing the
alternatives
available i.e.
which of these
options might
be most
effective in the
long run in
easing the
financial
burden on the
NHS?

14. Comparing Merit Goods and Public Goods
Merit Goods Public Goods
• Provided by both public & private
sector
• Normally funded and provided
by the government
• Positive marginal cost of
supplying to extra users
• Collective consumption – provide
to one and you provide to all
• Limited in supply – potentially
high opportunity cost
• Largely unconstrained in supply
• Rival – consumption by one
reduces availability to others
• Non-rival in consumption
• Excludable e.g. private health
care and education
• Non-excludable – giving rise to
the free rider problem
• Rejectable by those unwilling to
pay for the good or service
• Non-rejectable – usually funded
by general taxes

15. Get help from fellow
students, teachers and
tutor2u on Twitter:
@tutor2u_econ

16. Tutor2u
Keep up-to-date with economics,
resources, quizzes and
worksheets for your economics
course.