Demerit good – definition

A demerit good is a good which when consumed generates costs beyond those borne by the consumer.  Indeed, with a demerit good the private costs themselves may not be fully understood, and any external costs on third parties may be fully recognised. Hence there may be two types of information failure associated with consumption – firstly, the failure of the individual consumer to recognise and measure the costs to themselves, and secondly the failure to recognise and measure the costs to others.

The example of alcohol consumption provides clues about the nature of demerit goods. Firstly, the individual drinker may be unaware at the point of consumption of the health costs to themselves of drinking, and unaware of the potential costs to others. Costs to others include the opportunity cost to the healthcare service (how else could those resources have been used?) and financial costs to employers in terms of absenteeism. There are also costs to the government in terms of lost tax revenues. Finally, with alcohol consumption, there are costs associated with the recklessness of drinkers in terms of traffic accidents and damages arising from anti-social behaviour.

The welfare loss associated with the consumption of demerit goods can be shown diagrammatically:

demerit good