OCR A Level Economics: Information failure, merit and demerit goods, public goods and inequity (H460)

This guide follows the OCR A Level Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021. It covers three topics from the area of study Market failure and government intervention in Component 01, Microeconomics: Market power/Information asymmetries, Public goods, and Inequity. The specification labels no content as AS or Extension. Every figure and country below is invented and illustrative.

Externalities, the environment, efficiency, intervention methods, cost-benefit analysis and government failure are taught elsewhere. Use the OCR Economics hub and the printable checklist to see the whole course, and the free diagnostics to find weak spots. Companion pages: the revision notes and the practice questions. The Microeconomics overview gives the wider context.

What this unit covers

Topic	You must be able to
Information asymmetries	Explain information failure, asymmetric information and moral hazard; use a diagram to show how information failure causes market failure
Merit and demerit goods	Explain them, including in terms of information failure; evaluate their significance
Public goods	Define private, public and quasi-public goods and distinguish them; explain the four characteristics; explain the free rider problem and market failure; evaluate significance and the government’s role in provision
Inequity	Explain causes of income and wealth inequality; evaluate their significance; explain and evaluate differences in access to resources

Information failure

Markets work best when buyers and sellers are well informed. Information failure occurs when economic agents lack, or misjudge, the information needed to make a good decision. Price signals then fail to show true benefits or costs, so resources are misallocated.

Asymmetric information is a form of information failure where the buyer and seller do not hold the same knowledge, one side being better informed. A seller of a second-hand car usually knows its history; the buyer does not.

A worked example of asymmetric information

In an illustrative used-car market, a good car is worth £6,000 to a buyer and a poor one £2,000. Half the cars offered are good, but buyers cannot tell which. Sellers of good cars will not accept less than £5,000.

• Expected value to a buyer: 0.5 × 6,000 + 0.5 × 2,000 = £4,000.
• Buyers will pay at most about £4,000.
• Owners of good cars want £5,000, so they withdraw.
• Only poor cars remain, so buyers who realise this offer £2,000.

Good cars that would have traded never reach the market. This is sometimes called adverse selection, and the market is smaller than it should be.

Moral hazard occurs when a person changes behaviour after a risk has been transferred to someone else, because they no longer bear the full cost. Insurance is the standard case.

Worked example: an insurer prices cover on a 4% chance of a £10,000 claim. Expected claim = 0.04 × 10,000 = £400. After taking full cover, drivers become less careful and the chance rises to 6%. Expected claim = 0.06 × 10,000 = £600. That is £200 or 50% higher than the premium was built on. The insurer must raise premiums or add an excess, and careful drivers pay more.

How information failure causes market failure

Take a good whose true benefit to the consumer is lower than the consumer believes. Use illustrative functions, quantity in thousands, price in £.

• Marginal private benefit (MPB, the demand curve as consumers perceive it): 20 − 2Q.
• Marginal social benefit (MSB, the true benefit): 16 − 2Q.
• Marginal cost (supply): 2Q. There is no externality, so only information failure is at work.

Output (Q)	Market price	Perceived MPB	True MSB	MC
4	8	12	8	8
5	10	10	6	10

1. Market equilibrium: 20 − 2Q = 2Q, so Q = 5, price £10.
2. Social optimum: 16 − 2Q = 2Q, so Q = 4, price £8.
3. At Q = 5, MC = 10 but MSB = 6, a gap of £4.
4. Welfare loss = ½ × (5 − 4) × £4 × 1,000 = £2,000.

In words: draw the MPB curve above the MSB curve, with MC rising. The market produces where MPB crosses MC, to the right of the social optimum where MSB crosses MC. The triangle between MC and MSB from Q = 4 to Q = 5 is the welfare loss. This shows over-consumption because consumers overestimate benefits.

If consumers instead underestimate the benefit, the MPB curve lies below MSB and the market under-consumes. Let MPB = 12 − 2Q, MSB = 16 − 2Q and MC = 2Q.

• Market: 12 − 2Q = 2Q, so Q = 3, price £6.
• Optimum: 16 − 2Q = 2Q, so Q = 4, price £8.
• At Q = 3, MSB = 10 and MC = 6, a gap of £4. Welfare loss = ½ × 1 × 4 × 1,000 = £2,000.

Merit and demerit goods

A merit good is consumed too little (and so under-provided) by the free market because buyers undervalue what it does for them, or because the benefits reach beyond the buyer. A demerit good is over-consumed because consumers underestimate its harm or overestimate its benefit.

In terms of information failure, consumers lack full information. They may misjudge long-term effects (a dental check-up, a diet high in sugar), may not know the true benefit (training, vaccination), or may be influenced by habit, advertising or addiction. Merit goods are typical of the second diagram above and demerit goods of the first.

Evaluating their significance

Significance depends on the size of the gap and the nature of the good.

• Scale: the welfare loss in the example depends on the distance between MPB and MSB. A small misjudgment matters little; a large one matters a great deal.
• Value judgement: deciding that a good is “merit” or “demerit” means someone has decided consumers are wrong. This is normative, and governments may disagree with consumers (paternalism).
• Other causes: under-consumption of a merit good may also come from low income, not a lack of information. Giving information does not help someone who cannot afford the good.

The case is strongest where harm or benefit is large, evidence is clear and information alone will not change behaviour.

Public goods

A private good is excludable and rival. A bakery loaf can be withheld from non-payers, and once I eat it you cannot. A public good has characteristics that make private provision at a profit very difficult. A quasi-public good has some, but not all, of these characteristics, or has them only up to a point.

The characteristics

1. Non-excludable: non-payers cannot be prevented from benefiting.
2. Non-diminishable (non-rival): another user’s enjoyment does not use the good up.
3. Non-rejectable: you cannot choose to opt out even if you want to. A nation’s defence protects you whether or not you wish it.
4. Zero marginal cost: supplying the good to one more person costs nothing extra, so the efficient price for use is zero.

Good	Excludable?	Rival?	Type
Bread	Yes	Yes	Private
Street lighting	No	No	Public
Uncongested road, tolls possible	Yes	No (until it is busy)	Quasi-public
Congested road	Yes	Yes (delay for others)	Quasi-public, close to private

Few goods are purely public; most real examples are quasi-public.

The free rider problem

A free rider enjoys the good without contributing. If a good is non-excludable, each person expects others to pay and so contributes nothing.

Worked example. A village of 100 households values new street lighting at £30 each. Cost is £2,000.

• Total benefit = 100 × 30 = £3,000, above cost, so it should be built.
• Equal share = 2,000 ÷ 100 = £20 per household, below each household’s £30 valuation.
• Suppose only 40 households pay £20: 40 × 20 = £800, which is £1,200 short.
• To fund it from 40 payers each would pay 2,000 ÷ 40 = £50, above the £30 value, so they would refuse.

The light is not built, although the benefit exceeds the cost. Private firms cannot charge, so they do not supply it either.

Market failure and significance

Public goods cause market failure because the market fails to provide them, or provides too little. This is a missing market. Resources are not allocated to goods that would raise welfare. Because an extra user costs nothing, charging a positive price would deter use that costs society nothing.

Significance is high for goods that underpin a society, such as defence, street lighting and flood protection. It is smaller where users can be charged, or where charities or communities provide the good voluntarily.

The role of government in provision

The government can provide the good directly and fund it from taxation. In the village example, a tax of £2,000 ÷ 100 = £20 per household makes everyone pay.

Arguments for provision: it solves free riding, allows efficient (zero) pricing, and benefits can be shared by all.

Arguments against or limits: the government does not know how much people truly value the good, so the right quantity is uncertain; funding has an opportunity cost; and provision may be inefficient. Private firms might supply quasi-public goods through tolls or advertising, or the state might fund and a firm deliver. Weigh these using the example given.

Inequity

Income is money received over a period (wages, rent, interest, profit, benefits). Wealth is the value of what a person holds on one date, less what they owe. Both can be unequally distributed.

Worked example. A household owns a house worth £320,000 with a £120,000 mortgage and £15,000 savings. Net wealth = 320,000 − 120,000 + 15,000 = £215,000. Its income is £30,000 a year, so wealth is 215,000 ÷ 30,000 ≈ 7.2 times annual income.

Causes of income inequality

• Differences in skills, education and productivity, and so in wages.
• Differences in occupations, with labour scarcity raising pay in some roles.
• Unemployment or inactivity.
• Discrimination and unequal opportunity.
• Ownership of assets, which yields rent, interest and profit.
• Taxes and benefits, which can narrow or widen gaps.
• Technology and market power, which can raise returns to some skills.

Causes of wealth inequality

• Inheritance: £80,000 left to a child grows to 80,000 × 1.04²⁰ ≈ £175,290 at 4% over 20 years, without any effort.
• Saving and compounding: saving £3,000 a year at 4% for 20 years gives about £89,334, from £60,000 paid in.
• Rising asset prices help owners: a 6% rise on a £200,000 house is £12,000, while a renter gains nothing.
• High income allows more saving, so income inequality feeds wealth inequality.

Differences in access to resources

People with equal ability do not always reach the same resources. Reasons include:

• Income and wealth: private tutoring at £40 an hour for 30 hours costs £1,200. For a household on £18,000 that is 6.7% of income; for one on £90,000 it is 1.3%.
• Location: rural or poorer areas have fewer schools, clinics and jobs.
• Information and networks: families with experience of higher education or professions know how to enter them.
• Borrowing limits: people without collateral may not get credit.

Evaluating significance

• Equity: many see wide gaps as unfair. This is a normative view.
• Efficiency: wasted talent lowers output, and a lack of education reduces productivity.
• Social effects: health, crime and cohesion may suffer.
• Counter-view: some inequality rewards effort and risk and creates incentives. Equality of opportunity may matter more than equality of outcome.
• Size and mobility: a modest gap differs from a severe one, and it matters whether people can move between income levels over time.

Taxes and benefits can reduce gaps. Gross incomes of £90,000 and £18,000 (ratio 5.0) become, after £27,000 tax on the first, and £1,800 tax and £2,400 benefit on the second, £63,000 and £18,600. The ratio falls to about 3.4.

Common errors

• Describing a demerit good as simply “harmful”: the key is that consumers misjudge the harm.
• Defining a public good as “something the state supplies”. That describes a solution, not the good.
• Treating non-rivalry and non-excludability as the same thing.
• Confusing income with wealth, or flow with stock.
• Asserting “inequality is bad” without evaluation.

Official syllabus

OCR, A Level in Economics (H460) specification, Version 3.0 (June 2026), for first assessment in 2021, topics Market power/Information asymmetries, Public goods and Inequity.