Merit good – definition

A merit good is a good which when consumed provides external benefits, although these may not be fully recognised – hence the good is under-consumed. Examples include education and healthcare.

positive consmption externality diagram

As can be seen, when a merit good is consumed it generates positive externalities. The most socially efficient allocation of resources to the production of a merit good would occur at the quantity which equates marginal social benefit (MSB) with marginal social cost (MSC) – namely, the output that takes into account the external costs and benefits, and not just the private ones.

If externalities are not taken into account, as is likely to be the case if merit goods are supplied exclusively by free markets, then there will be a net welfare loss, as shown by area A,B,C in the above diagram.