MODULE NO.
: _4__ Teacher: Cristiano
Subject: ECONOMICS DATE: Feb 11 -Feb 17,2024
International School Parent’s Signature:_________
TOPIC: CLASSIFICATION OF GOODS
LEARNING OBJECTIVES: Students should be able to explain ( identify/outline)
nature and definition of free goods and private goods (economic goods)
nature and definition of public goods
nature and definition of merit goods: under-consumption as a result of
imperfect information in the market
nature and definition of demerit goods: over-consumption as a result of
imperfect information in the market
RESOURCES: Cambridge AS and A level Economics by Colin Bamford & Susan
Grant
CLASSIFICATION OF GOODS AND SERVICES
Goods and services have so far been referred to in general terms.
Economists classify goods and services into three groups:
1 A small number of goods and services that are free for everyone to use.
2 Goods and services that individuals have to pay for through the market
mechanism.
3 Goods and services that are provided for everyone by the government.
Excludability and rivalry
Excludability and rivalry are the two characteristics used by economists to
determine the type of goods:
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• A good is excludable (or exclusive) if other consumers can be prevented from using
or consuming it. An example is the latest smartphone that you might have bought. A
good is non-excludable if it is freely available and nothing can be done to prevent its
consumption.
• A good is rival if only one person can consume it and in doing so the good is not
available for other consumers. An example is a lunchtime meal or a pair of trainers.
Most goods are rivalrous. A good is non-rival when the amount available to others
does not diminish.
Private goods
The fundamental economic problem of scarce resources in relation to unlimited
wants only arises in situations where economists are dealing with private goods.
Private goods are also known as economic goods since they have a cost in terms of
the resources used and are scarce. Therefore, a price must be charged when private
goods are used or consumed. This applies to most of the goods and services we are
likely to buy regularly, such as food items, drinks, clothing, household goods and
petrol.
Private goods are bought and consumed by individual consumers or firms for their
own benefit. They have two important characteristics:
• Excludability: It is possible to exclude some people from using a private good.
This is normally done through charging a price. If the price is not acceptable, then
the good will not be consumed. Once a private good has been purchased by one
person, it cannot then be consumed (purchased) by others.
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• Rivalry: The consumption by one person reduces the availability for others. In
some ways it seems obvious that when you purchase food, clothes or a textbook,
fewer of these goods are then available for purchase by others.
Free goods
Free goods have zero opportunity cost since consumption is not limited by scarcity.
Free goods have no prices and, in principle, no factors of production are required to
produce them. It is not easy to think of examples. In some economies, wild fruit and
berries may be gathered or some non-domesticated animals hunted for their meat.
The air we breathe could also be seen as a free good. Other examples include
rainfall and water in a local river.
Public goods
A public good has two characteristics.
• A public good must be non-excludable. Once the good has been provided for one
consumer, it is impossible to stop anyone else from benefiting from the good.
• A public good must be non-rival. As more and more people consume the good, the
benefit to those already consuming the product must not be reduced. Some goods
are public goods in most economies. Fire protection, the police force, national
security, street lighting, traffic lights and floodcontrol systems are all public
goods. A government-funded flood control system, by its very nature, is in place for
the benefit of anyone who might be badly affected by flooding. It is non-rivalrous in
the sense that each person living in the vicinity of the flood control system has the
same accessibility to its support. It is unrealistic to charge individuals for the
protection; what happens if you pay a charge and your near neighbour refuses to
pay?
In coastal areas, a lighthouse is an excellent example of a public good. (A lighthouse
is a tall structure with a powerful light that is designed to warn shipping of
dangerous rocks or shallow water). A lighthouse is non-excludable since the service
is available to all vessels in the area. It is non-rivalrous since all ships receive the
same warning from the lighthouse’s powerful light beam. It is impractical to charge
individual ships as they pass by the lighthouse.
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Quasi-public goods
Flood control systems and lighthouses are often referred to as pure public goods.
This is because they are clearly non-excludable and nonrival. Some goods that may
appear to be public goods do not meet both of these characteristics in full. For this
reason, such goods are known as quasi-public goods. A toll road is a typical
example. It is non-rivalrous like a public good but excludable like a private good
since anyone not paying the toll is excluded from using it.
Another example of a quasi-public good might be a sandy seaside beach. The beach
is available to all those who wish to use it. It appears non-excludable. However, it is
possible to think of ways of excluding consumers from the beach. Privately owned
beaches do this. Equally, the beach is non-rival up to a point. If you are the first
person on a pleasant beach on a warm, sunny day, you may continue to enjoy the
beach as a few more people arrive to enjoy the benefits themselves.
However, as the beach becomes crowded, space limited and other people’s
conversations and music become louder, you may no longer enjoy being on the
beach. The beach has something of the characteristic of non-rivalry, but not the full
characteristic. It is a quasi-public good.
The problem caused by public goods
The problem that may be caused in a free market by the existence of public goods is
a serious one: the market may not produce them. There may be a consumer
demand for such products (consumers are willing and able, in principle, to pay for
the product’s services), but the free market may not have a mechanism for
guaranteeing their production.
In the case of a flood control system and a lighthouse, we have hinted at what is
known as the free rider problem associated with the provision of public goods. The
free rider problem arises where people enjoy the
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benefits of a public good without having paid for it. In other words, they take a ‘free
ride’. The problem is due to the non-excludability of public goods.
Take the case of a non-toll road which is funded by the regional government out of
taxation. Anyone who is qualified to drive and who has a vehicle can use it. There is
no direct user charge at the point of use. So, tourists and non-local people are free to
use the road in the same way as local residents who have contributed to its funding.
If the road was to be provided by a private business, this would still be the case.
Given that a private firm would be seeking to make a profit, there is no way that it
would consider building a non-toll road. The same argument applies to providing fire
prevention and police services.
The existence of public goods may mean that scarce resources are not used in a
way that would be desirable. People may wish for the provision of such goods, but
the demand may never be registered in the market. However, private goods can be
rejected if the price is too high or the quality is not what is expected. These
seemingly obvious qualities of private goods are useful since they help us
understand what is meant by public goods.
Merit goods, demerit goods and information failure
A merit good is a good that is thought to be desirable but which is underprovided by
the market. For example, an inoculation against a contagious disease is a merit
good. Other people benefit from the inoculation, as they will not now catch the
disease from the inoculated person.
A demerit good, on the other hand, is seen as any product that is thought to be
undesirable and which is overprovided by the market. Eating too much ‘junk food’ is
a demerit good because overconsumption of fatty foods with few nutrients may
cause ill health. Governments tend to provide merit goods, since there is likely to be
underproduction and underconsumption. The opposite is the case with demerit
goods where there is likely to be overproduction and overconsumption, largely
because these are goods that are habitforming, fairly cheap and readily available.
Information failure and underconsumption of merit goods
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To further understand merit goods and demerit goods, you need to know that there is
information failure applying to the consumer. Information failure arises because
consumers do not recognise how good or bad a particular product is for them: either
they do not have the right information or they simply lack some relevant information.
This is why merit goods are provided by the government for those who are thought
to need them.
There is a huge quantity of information on a wide range of products available to
consumers on the internet to help them make informed decisions about what to buy.
In some countries, better labelling on consumer products, such as food, drink and
non-prescription medicines, can help consumers when deciding what to buy.
For other products, such as tobacco products and medicines, the labelling may
contain reasons to stop or limit the consumption of a product. In principle, the ever-
increasing information available to consumers should enable them to take rational
decisions that maximise consumer welfare. Where this happens, the market works
efficiently; if not, there will be an inefficient allocation of resources.
Specific examples of information failure are:
• where consumers are not aware of the benefits or the harmful effects of consuming
a particular product
• where persuasive advertising results in consumption levels that are not in the best
interests of consumers
• where product packaging makes claims that are misleading or inaccurate
• where producers know more about a product than consumers.A
Low income and underconsumption of merit goods
As well as information failure, a further reason for the underconsumption of merit
goods is low income. Consumers may recognise the benefits of merit goods but lack
the disposable income to be able to afford to buy the goods in the quantity they
would like or not at all.
This is typically the case with education and healthcare:
• All forms of education and training, if successfully completed, should produce
benefits to the individual in terms of improved and new skills, better pay and positive
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employment prospects. There are wider benefits to the economy – a better qualified
workforce is an important source of economic growth and can improve the
competitiveness of an economy.
• A healthy population benefits both individuals and the economy. If people have to
pay for access to doctors, hospitals and medicines, then there will be
underconsumption among low-income families. It is morally wrong that only better-off
families can use healthcare services in full; for this reason most governments try to
provide a minimum level of health care for their [Link]
Equally, consumers may be ignorant of the harmful effects of demerit goods on
themselves and on others. Consumers might be indifferent, choosing not to care.
This is particularly true of ‘junk food’ which is of low nutritional value, readily
available, cheap and quick to consume. In high-income economies especially, adult
and child obesity is already a serious problem and expected to get worse. Obesity
can be partly attributed to the overconsumption of fast-foods and high-sugar drinks,
especially in low-income households.
Smoking, especially passive smoking, is another example of a demerit good.
Smoking is often no longer allowed in public places, such as offices and restaurants.
Governments seek to reduce cigarette consumption by imposing heavy indirect
taxes, advertising restrictions and health warnings and images on cigarette packets.
It is not possible to say with certainty whether these measures are effective, not least
because cigarette smoking is still popular among young people in many countries.
The ban on smoking in public places has been more successful.Y 6.1
Some economists argue that there is no such thing as merit goods and demerit
goods. They put forward the view that in health care and smoking, it should be the
individual and not the government who knows what is best for them. This contradicts
the underlying assumption that the government knows better than the individual what
is good or bad for them because it has considerable information at its disposal.
An important question with regard to merit and demerit goods is ‘Who is to say what
is ‘good’ or ‘bad’ for a person’? If an individual consumer makes a decision to
consume a product, what right has society to say that the individual is making a
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‘wrong’ decision? If society is able to tell consumers that they do not fully realise
what is good or bad for them, then it follows that ‘society knows best’ and has a right
to make value judgements.
EXAM-STYLE QUESTIONS: MULTIPLE CHOICE
1 Which of these is a distinctive characteristic of a pure public good?
A Consumption by one person means that there is less available for another person.
B Nobody can be excluded from consuming it.
C It is produced by the government.
D It is free of charge at the point of use or consumption.
2 Which of these is a distinctive characteristic of a merit good?
A It is overprovided in the market.
B It is underprovided in the market.
C It is funded by the government.
D It is only given to those who deserve it.
3 Which of these is a distinctive characteristic of a demerit good?
A It is overprovided by the market.
B It is underprovided by the market.
C It is paid for by individuals.
D Anyone can buy it.
4 Which of these is most likely to be a merit good?
A a local public library
B cigarettes
C sea defences
D satellite television
5 The vaccination of a child against polio is a merit good because:
A the child’s family cannot afford the vaccination.
B it protects the child from polio.
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C it is underprovided by the market because of information failure.
D it provides employment in the pharmaceutical industry.
Essays
2 a A middle-income country increases its expenditure on capital goods, with no
increase in expenditure on consumer goods. With the help of a diagram, explain how
this affects the country’s production possibility curve and consider whether
producers or consumers will benefit most from the change. [8]
b Discuss how the allocation of consumer goods and capital goods differs between a
planned economy and a market economy. [12]
3 a A public good has the characteristics of non excludable and non-rival. Explain
how these characteristics can be applied to the provision of flood defences and
consider which of the characteristics is most important. [8]
b Discuss the extent to which libraries and museums should be provided by the
government or by the private sector. [8]
