Draw perceived and actual MPB for a merit and a demerit good, and shade the welfare loss
6 min
4 questions
Key terms
Perceived marginal private benefit
Perceived marginal private benefit is the benefit buyers believe the last unit gives them, which sets their demand even when the belief is wrong.
Actual marginal private benefit
Actual marginal private benefit is the benefit the last unit really gives buyers, as they would judge it with full information.
A merit good is under-consumed
1 of 3
What buyers seeBuyers act on perceived MPB, so the market settles where it meets MPC, at Q1 and P1.
Buyers underestimate the benefit, so the market stops at Q1 and P1. With full information they would buy Q2 at P2, further to the right.
Demand rests on the benefits buyers perceive. Buyers of a merit good, such as a pension or a dental check-up, underestimate what it does for them, so perceived MPB lies below actual MPB.
Buyers stop at Q1, where perceived MPB meets MPC. Actual MPB meets MPC at Q2, so with full information they would buy more.
Each unit from Q1 to Q2 is worth more to the buyer, on actual MPB, than it costs to make, on MPC. The welfare loss is the triangle W between actual MPB and MPC, from Q1 to Q2.
The diagram assumes no external effects, so MPC is also MSC and actual MPB is also MSB. A good with spillover benefits as well has MSB further right still.