Implications of misallocation of resources in relation to the under-consumption of merit goods and goods with external benefits

Published by Patrick Mutisya · 14 days ago

IGCSE Economics 0455 – Allocation of Resources: Market Failure

Topic: The Allocation of Resources – Market Failure

Learning Objective

Explain the implications of mis‑allocation of resources when merit goods and goods that generate external benefits are under‑consumed.

Key Concepts

  • Merit Goods: Goods that provide greater social benefits than the private benefits perceived by individuals (e.g., education, vaccinations).

  • External Benefits (Positive Externalities): Benefits received by third parties not reflected in the market price (e.g., a well‑maintained garden improving neighbourhood aesthetics).

  • Market Failure: A situation where the free market does not allocate resources efficiently, leading to a divergence between private equilibrium and socially optimal equilibrium.

Why Do Merit Goods and Positive Externalities Tend to Be Under‑Consumed?

  1. Consumers consider only their private marginal benefit (PMB) and ignore the marginal benefit to society (SMB).

  2. Since PMB < SMB, the market equilibrium quantity (Qm) is lower than the socially optimal quantity (Qs).

  3. Information asymmetry or lack of awareness can further depress demand.

Diagrammatic Representation

Suggested diagram: Demand curve (PMB) intersecting supply (MC) at market equilibrium (Qm); a second curve (SMB) lies above PMB, intersecting MC at socially optimal equilibrium (Qs).

Mathematical Illustration

The welfare loss (dead‑weight loss) from under‑consumption can be expressed as:

\$\$

\text{DWL} = \int{Qm}^{Q_s} \bigl[SMB(Q) - PMB(Q)\bigr] \, dQ

\$\$

Implications of Mis‑allocation

DimensionEffect of Under‑ConsumptionPotential Economic Consequences
HealthFewer vaccinations, lower immunisation ratesHigher incidence of preventable diseases; increased public health expenditure
EducationReduced enrolment in primary/secondary schoolingLower human capital formation; reduced productivity and long‑term growth
EnvironmentInsufficient investment in green spaces, pollution controlExternal costs borne by society (health impacts, loss of biodiversity)
InnovationUnder‑investment in research & developmentSlower technological progress; competitive disadvantage internationally

Government Intervention to Correct Under‑Consumption

  • Subsidies: Reduce the effective price faced by consumers, shifting the private demand curve upward toward the social demand curve.

  • Public Provision: Directly supply merit goods (e.g., free schooling, NHS services).

  • Regulation & Mandatory Requirements: Compulsory vaccination programmes, school attendance laws.

  • Information Campaigns: Increase awareness of the broader benefits, moving perceived private benefit closer to social benefit.

Evaluating Intervention Strategies

Policy ToolAdvantagesLimitations / Potential Drawbacks
SubsidiesCost‑effective; retains consumer choice; can be targeted.Fiscal burden on government; risk of over‑consumption if set too high.
Public ProvisionEnsures universal access; can achieve economies of scale.Requires substantial public funding; possible inefficiencies in delivery.
Compulsory MeasuresGuarantees minimum consumption levels; addresses severe externalities.May be perceived as paternalistic; enforcement costs.
Information CampaignsLow cost; empowers consumers; can complement other measures.Effectiveness depends on public receptiveness; may not change behaviour alone.

Summary Points

  • When private marginal benefit is lower than social marginal benefit, markets under‑provide merit goods and goods with positive externalities.

  • The resulting dead‑weight loss represents a loss of total welfare.

  • Governments can intervene through subsidies, public provision, regulations, or information to move the market outcome toward the socially optimal level.

  • Each intervention has trade‑offs that must be weighed against fiscal constraints and equity considerations.