A demerit good is defined as a good which can have negative impact on the consumer – but these damaging effects may be unknown or ignored by the consumer. Demerit goods also usually have negative externalities – where consumption causes a harmful effect to a third party.
Examples of demerit goods
- alcohol, cigarettes, drugs.
The classification of demerit goods is a normative judgement. In defining demerit goods we may assume that people are irrational and make poor choices – often consuming goods which are harmful. This may be due to poor information or poor decision making. In other words people may under-estimate the private costs and over-estimate the private benefits.
Demerit goods have these two characteristics:
- 1) Harmful to individual consumer
- 2) Also have negative externalities. (Costs imposed on third parties)
For example, why alcohol is considered a demerit good
- Consuming alcohol can cause personal health problems. But, we may ignore the damage to the liver from consuming excess quantities of alcohol.
- Consuming alcohol can also cause costs to other people (external costs), such as increased levels of crime and cost of treating disease.
With a good like alcohol, you could say it only becomes a demerit good when consumed in excess. e.g. one unit a day is unlikely to cause either much personal damage or negative externality. But, when consumed in excess, the personal and external costs can be very high.
A good with negative externalities (e.g. driving a car) isn’t necessarily a demerit good. Driving a car causes pollution (negative costs to other people). But, we don’t usually assume that driving a car is bad for you. Therefore it would not be classed as a demerit good, just a negative externality.
More examples of demerit goods
For some goods it is not clear whether it is a demerit good or not. For example to some people, contraception and abortion would be considered a demerit good (contraception a sin according to Catholic church), to others they may be considered beneficial (contraception helps spread STD) and therefore a merit good.
Dealing with demerit goods
To reduce demand for demerit goods, the government may:
- Place a tax on the good, e.g. tobacco tax
- Place regulations on the consumption, e.g. legal minimum age of 18.