Chapter 5 · Market failure and socially undesirable outcomes I: Common pool resources and negative externalities
Information & advertising
Explore how information about harmful consumption may reduce demand. Compare the assumed consumer response with the socially efficient outcome.
The economic idea
Imperfect information exists when consumers or producers do not possess accurate, complete or usable information for decision-making. Asymmetric information is the narrower case in which one party to a transaction has more or better information than another.
A demerit good is considered harmful and may be overconsumed because consumers underestimate its private costs, discount future harm or are affected by addiction and behavioural bias. A negative consumption externality is different: it concerns costs imposed on third parties.
Information provision, education and advertising campaigns attempt to improve choices by changing knowledge, attention, beliefs or social norms. They are non-price policies: no tax wedge is created and the production cost curve need not shift.
In this model, the campaign lowers perceived marginal private benefit and shifts the post-campaign demand curve toward marginal social benefit. Consumption then falls along the unchanged cost curve.
The policy reaches the allocatively efficient quantity only if the assumed change in private demand is large enough to make the post-campaign market outcome coincide with the point where marginal social benefit equals marginal social cost.
Reading a campaign that reduces but does not remove overconsumption
“Price” is measured vertically and “Quantity” horizontally.
“MPB” shows consumers’ original perceived private benefit. “MSB” records benefit to society after external harm is deducted.
“MSC = MPC” is unchanged because this diagram models a demand-side response rather than a change in production cost.
“MPB after campaign” is the demand curve after the assumed campaign response. It is not automatically equal to “MSB” and is not itself a social-benefit curve.
Before the campaign: Eₘ
“Eₘ” is where “MPB” meets “MSC = MPC”, producing “Qₘ”. Consumers act on their original private valuation.
Social benchmark: E*
“E*” is where “MSB” meets “MSC = MPC” and gives “Q*”, the quantity that satisfies MSB = MSC.
After the campaign: E₂
Consumption falls from “Qₘ” to “Q₂”, but “Q₂” remains above “Q*”. The assumed information response reduces, but does not eliminate, overconsumption.
Test the response, not just the message
The shift to “MPB after campaign” represents an assumption about behaviour. It does not mean the campaign changes the underlying third-party harm on “MSB” or the production cost on “MSC = MPC”. Check whether the resulting “Q₂” is closer to “Q*”.
Reducing consumption toward “Q*” removes units for which “MSC = MPC” exceeds “MSB”. Any remaining loss is assessed with those social curves, not with the gap between the old and new private-demand curves. Campaign spending and the evidence for a lasting response also matter.
How the campaign is assumed to affect choice
Consumers initially choose from “MPB”, so the market reaches “Eₘ” and “Qₘ”.
The campaign supplies information or changes the salience of harm, lowering perceived marginal private benefit to “MPB after campaign”.
The lower private valuation reduces quantity demanded at every price and creates a new intersection with “MSC = MPC” at “E₂” and “Q₂”.
Compare “Q₂” with “Q*” rather than assuming that any fall in consumption is sufficient. Consumption falls from “Qₘ” to “Q₂”, but “Q₂” remains above “Q*”. The assumed information response reduces, but does not eliminate, overconsumption.
What the current state establishes
The graph shows a hypothesised response. It does not demonstrate that real consumers will process, believe or act on the information to the same extent.
Common mistakes to avoid
- “MPB after campaign” is not “MSB” unless the two visibly coincide. One records private choice after a campaign; the other is society’s benefit schedule.
- A campaign does not create a tax, tax revenue or a movement along an unchanged demand curve. The model represents a shift in demand.
- Private harm to the consumer supports a demerit-good or information-failure argument; an externality additionally requires harm to a third party.
- A smaller quantity is not automatically better. If the response pushes consumption below the social optimum, the policy over-corrects in the model.
How to draw this diagram
- Title the diagram “Information & advertising”. Label the horizontal axis “Quantity” and the vertical axis “Price”.
- Draw MPB first and label it clearly.
- Draw MSC = MPC next and label it clearly.
- Draw MSB next and label it clearly.
- Draw MPB after campaign next and label it clearly.
- Mark each relevant intersection and distinguish the initial, market and socially optimum or policy outcomes where applicable.
- Add the relevant guide lines and shade the economic area only after its boundaries are established.
- Check that every symbol used in the explanation appears on the diagram and add arrows showing the direction of change.
Assumptions and limitations
- The size of the demand response is assumed by the diagram rather than estimated from evidence.
- Information may have little effect when habits, addiction, peer effects or present bias dominate deliberate choice.
- Different consumers have different prior knowledge and ability to act, so one campaign can have unequal effects.
- Messages can lose salience over time or be offset by commercial advertising and misinformation.
- Information alone cannot fully internalise a pure external cost when informed consumers still have no private incentive to consider third-party harm.