In this video, you're going to take a look at what is meant by merit and demerit goods, and then you're going to take a look at why these goods may be over or under consumed. Education is considered a merit good because it gives more benefits to the individual who consumes it than they actually realize at that time. Now, the argument goes that merit goods generally have greater value to people than they realize, and they generate positive externalities.
I'll explain externalities a little bit later in this video, but I want to draw your attention to the fact that they have this positive benefit to people who didn't necessarily consume the education. What that means is arguably people who go to school tend to be more productive members of society, and with higher levels of education, arguably the likelihood of committing crime is decreased, or so the argument goes. Now on the other side of that, so this is merit goods that have these positive spillover effects. that have more value to people than they realize, you have something like pollution. Now, I'm going to step back a sec from merit goods and demerit goods and talk about pollution as an externality.
Now, an externality is a benefit or a cost to a third party who is not involved in a transaction. For example, this company is producing goods or energy or something that is not being consumed by somebody who is affected by this pollution. So that's an externality. It's that spillover cost or benefit. incurred by a third party.
A third party is defined as somebody who's not involved in the transaction as a result of the consumption or production of a good. Another way you can think about this is if you walk down the street and you walk by a bakery and you really enjoy the smell of fresh bread, you're not buying the bread, you're not producing the bread, but you're enjoying that value of that scent, that pleasant aroma. So that's a positive externality because you're enjoying it. and it's a third-party benefit to you. You're not involved in any of that process.
The other side of that is taking a look at something like smoking, right? Smoking, if you're walking behind somebody on the street who's smoking, or you're in a restaurant where somebody is still allowed to smoke, you're being harmed by their decision to smoke, that you're facing a cost of your health because they choose to consume cigarettes. The cigarette company got paid for the sale. The individual is smoking the cigarette, enjoying it, but you are facing...
an undesirable cost to your health because of this transaction. And cigarettes are considered demerit goods because we argue that they cause more harm to people than they realize. And like I just mentioned before, they have this negative spillover effect or the negative externality.
So we've seen merit goods and demerit goods. We've seen that merit goods tend to give rise to positive externalities and demerit goods tend to give rise to negative externalities. You should walk away from watching this video understanding what an externality is, as well as the definition of a merit and demerit goods with examples. Understand why they may be over-consumed or under-consumed on the basis of consumer information. We don't understand how valuable education is as a whole, so we tend to under-consume it.
If we saw the true value of education, maybe more people would be going to school. Also, we have something like smoking and cigarettes. These are demerit goods that if we really understood the harm we were causing ourselves and society, arguably we would consume less.
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I'll see you in unit two.