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In budget 2021, the price of a 20 pack of cigarettes rose from €13.50 to €14.00 - Leaving Cert Economics - Question 4 - 2021
Question 4
In budget 2021, the price of a 20 pack of cigarettes rose from €13.50 to €14.00. Cigarettes are classed as 'Demerit Goods' and as such their purchase constitutes a ... show full transcript
Worked Solution & Example Answer:In budget 2021, the price of a 20 pack of cigarettes rose from €13.50 to €14.00 - Leaving Cert Economics - Question 4 - 2021
Step 1
Explain your understanding of the economic term Demerit Goods.
Answer
Demerit goods are goods whose positive effect is overestimated by consumers and which have negative effects which consumers possibly underestimate or are unaware of. They tend to be over-consumed due to the lack of awareness about their harmful consequences.
These goods usually have negative externalities, i.e., they have negative effects on third parties not involved in the consumption of the goods. An example is cigarettes, which impact public health and impose costs on healthcare systems.
Step 2
Explain why the purchase of demerit goods, such as cigarettes, is seen as a market failure.
Answer
The purchase of demerit goods is seen as a market failure as the free market will lead to the production and overconsumption of a harmful good whereby the market price fails to reflect the true private or social cost of the product. If the free market were to take full account of the private and social costs of this product its price would be much higher, leading to potential overconsumption.
Step 3
Explain why the Irish Government intervenes by imposing higher taxes on cigarettes in budgets.
Answer
The government intervenes in order to increase the price to deter consumption of a good which is harmful for consumers and harmful for society in creating negative externalities. The revenue earned can help fund the costs of dealing with the negative externalities e.g., over-crowding of healthcare services.
The government feels the need to intervene in this market as if it is left to the free market to determine the price of the good, it will generate a price which is too low to reflect the true private and social cost of consumption of the good. This leads to overconsumption of a harmful product.