Chapter 6 · Market failure and socially undesirable outcomes II: Positive externalities, public goods, asymmetric information and inability to achieve equity
Education & nudges: merit goods
Show how information or nudges may increase demand for a merit good. Explain the assumed response and compare consumption with the social optimum.
The economic idea
A merit good is considered beneficial and tends to be underconsumed in a free market. Consumers may underestimate its private benefits because information is incomplete, benefits arise in the future or behavioural biases reduce attention and follow-through.
Information provision gives consumers relevant facts; education develops understanding; advertising increases awareness; and nudges alter the choice environment without removing options or materially changing prices.
These policies aim to raise perceived marginal private benefit and shift private demand toward the quantity consumers would choose with better information or decision support.
A positive consumption externality is separate: it exists when consumption also benefits third parties, placing MSB above MPB. Better information changes perceived private benefit; it does not mechanically change the external benefit received by society.
The campaign reaches the social benchmark only if the resulting private demand produces Q*. Too small a response leaves underconsumption, while an excessive assumed response can move consumption beyond the benchmark.
Reading education that reduces but does not remove underconsumption
“Price” is measured vertically and “Quantity” horizontally.
“MPB” represents marginal private benefit and “MSB” marginal social benefit.
“MSC = MPC” represents marginal private cost and “MSC = MPC” marginal social cost.
“MPB after education / nudges” shows the intervention currently applied. The distance between original MPB and post-intervention MPB is the model’s assumed behavioural response, not a measured social benefit.
Before intervention: Eₘ
“Eₘ” is the private-market equilibrium, where “MPB” meets “MSC = MPC”, giving “Pₘ” and “Qₘ”.
Social benchmark: E*
“E*” is where “MSB” meets “MSC = MPC” and gives “Q*”.
Post-intervention outcome: E₂
The intervention raises perceived marginal private benefit and shifts private demand right along the unchanged production-cost curve. The resulting outcome is “E₂” at “P₂” and “Q₂”. “Q₂” is above “Qₘ” but remains below “Q*”. The intervention reduces underprovision without eliminating it.
What the intervention changes, and what it does not show
The campaign changes consumers’ perceived private benefit, shown by “MPB after education / nudges”. Unlike a subsidy, it does not create a price wedge between consumers and producers. The response is a shift of demand, not a movement along the original private-demand curve.
More awareness is not the same as more consumption. Consumers must understand and trust the message and be able to act on it. Check the resulting quantity against “Q*”; the diagram does not measure campaign costs or prove that the assumed demand response will last.
How the education, advertising or nudge changes the outcome
The market initially reaches “Eₘ” and “Qₘ” because private decision makers follow “MPB” and “MSC = MPC”.
The social comparison uses “MSB” and “MSC = MPC”, producing the benchmark “E*” and “Q*”.
The intervention raises perceived marginal private benefit and shifts private demand right along the unchanged production-cost curve.
The new intersection is “E₂” and “Q₂”. “Q₂” is above “Qₘ” but remains below “Q*”. The intervention reduces underprovision without eliminating it.
What the current state establishes
“Q₂” is above “Qₘ” but remains below “Q*”. The intervention reduces underprovision without eliminating it.
A rise in activity is not enough to prove success; the remaining gap to Q* represents beneficial units still forgone.
Common mistakes to avoid
- The post-campaign demand curve is not MSB unless the two visibly coincide. One represents revised private choice; the other represents benefit to society.
- The intervention is not automatically optimal because “Q₂” exceeds “Qₘ”. It must be compared with “Q*” and evaluated against its costs.
- Government expenditure is not automatically deadweight loss, but it has an opportunity cost and may require distortionary taxation.
- The welfare conclusion depends on the current position of “Q₂” relative to “Q*”, not on the policy label alone.
How to draw this diagram
- Title the diagram “Education & nudges: merit goods”. 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 education / nudges 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 behavioural response is assumed by the graph rather than demonstrated by the campaign itself.
- Information cannot overcome price, time, transport or capacity barriers on its own.
- Responses can differ across income, age, language and prior knowledge, creating equity concerns.
- Nudges may fade, be ignored or raise concerns about paternalism and autonomy.
- Campaign costs and the opportunity cost of public attention are not shown.