OxfordAQA International AS and A-level Economics: Merit goods, imperfections, equity (9640) – Revision Notes

These notes boil down OxfordAQA International AS and A-level Economics (9640), specification version 1.2, sections 3.1.5.4 (merit and demerit goods), 3.1.5.5 (market imperfections) and 3.1.5.6 (inequitable distribution of income and wealth). Section 3.1 is International AS material that the full International A-level builds on. Read the study guide for the full explanations. Then try the practice questions, see the course hub and the printable checklist, and find gaps with the free diagnostics. All numbers here are invented and illustrative.

Key definitions

Term	Meaning
Market failure	A market outcome that misallocates resources
Merit good	Society judges people consume too little of it; underconsumed
Demerit good	Society judges people consume too much of it; overconsumed
Imperfect information	Buyers or sellers lack some relevant knowledge
Asymmetric information	The seller and buyer hold unequal knowledge
Monopoly power	Ability to set price above marginal cost by restricting output
Occupational immobility	Workers cannot switch jobs because skills do not transfer
Geographical immobility	Workers cannot or will not move to where work is
Income	Receipts over a period (a flow)
Wealth	Net assets owned at one moment (a stock)
Equality	Everyone has the same amount
Equity	Fairness and justice; a value judgement

Merit and demerit goods (3.1.5.4)

Key ideas

• Classification depends on a value judgement.
• Causes of misallocation: externalities in consumption, and imperfect information about benefits or harm.
• Spillovers in consumption alone do not make a merit or demerit good. Test: are consumers judged to under- or overvalue it?
• You need demand and supply diagrams only. MSC/MSB diagrams are not required.

Diagram in words. Draw one supply curve and two demand curves. Label the market demand “perceived benefit” and the other “full benefit”. Merit good: the full-benefit curve is to the right, so the market equilibrium output sits to the left of the desirable output. Demerit good: the full-benefit curve is to the left, so the market output is too high. Shade the triangle between the curves, from the market quantity to the desirable quantity.

Method in steps

1. Solve market demand = supply for P and Q.
2. Solve full-benefit demand = supply for the desirable P and Q.
3. Difference in quantities is the under- or overprovision.
4. Triangle area = ½ × price gap at the market quantity × quantity difference.

Worked reminder (merit good, illustrative). Perceived demand Qd = 84 − 3P, supply Qs = 12 + 3P, full-benefit demand Qd* = 120 − 3P.

• Market: 84 − 3P = 12 + 3P, so 6P = 72, P = 12, Q = 48.
• Desirable: 120 − 3P = 12 + 3P, so 6P = 108, P = 18, Q = 66.
• Underprovision: 66 − 48 = 18.
• At Q = 48, full-benefit price = (120 − 48)/3 = 24 and supply price = (48 − 12)/3 = 12. Gap = 12.
• Net benefit lost = ½ × 12 × 18 = 108.

Evaluation points: who decides, paternalism, changing tastes, an unobservable true demand curve, and the size of spillovers or information gaps.

Market imperfections (3.1.5.5)

Imperfection	Chain of reasoning
Imperfect or asymmetric information	One side cannot judge quality, so offers a price based on average quality, owners of good items withdraw, quality falls, and mutually beneficial trades do not happen
Monopoly power	Restricts output where MR = MC, price above marginal cost, output below the competitive level, deadweight loss
Factor immobility	Unemployed labour and unfilled vacancies exist at the same time, so output and incomes are lost and resources are not where they are most valuable
Price instability	Inelastic demand and supply plus supply shocks means big price swings, unstable incomes, less investment and more uncertainty

Worked reminder: asymmetric information. A good second-hand tablet is worth 900 and a poor one 300. A third are good, and buyers cannot tell them apart. Buyers offer 900 × 1/3 + 300 × 2/3 = 300 + 200 = 500. Good-tablet owners who want at least 700 withdraw. The market ends with poor tablets at about 300.

Worked reminder: monopoly. Demand P = 60 − Q, constant marginal cost 12.

• Competitive: 60 − Q = 12, so Q = 48 and P = 12.
• Monopoly: MR = 60 − 2Q = 12, so Q = 24 and P = 60 − 24 = 36.
• Profit: 24 × (36 − 12) = 576.
• Consumer surplus: ½ × 48 × 48 = 1,152 under competition and ½ × 24 × 24 = 288 under monopoly.
• Total surplus: 1,152 against 288 + 576 = 864, a deadweight loss of 288. Check: ½ × (36 − 12) × (48 − 24) = 288.

Worked reminder: price instability. Price elasticity of demand −0.25. As a rough guide, the price change needed = quantity change ÷ elasticity.

• Supply falls 8%: price rises about 8 ÷ 0.25 = 32%. Revenue index = 1.32 × 0.92 = 1.2144, so revenue is up 21.4%.
• Supply rises 8%: price falls about 32%. Revenue index = 0.68 × 1.08 = 0.7344, so revenue is down 26.6%.
• Result: incomes swing far more than output does.

Evaluate monopoly: economies of scale, funds for innovation, and the threat of entry can reduce the harm; the damage depends on how much power exists.

Inequitable distribution of income and wealth (3.1.5.6)

Must-know distinctions

Pair	Difference
Income and wealth	Receipts over a period, against net assets owned at one moment
Equality and equity	Same amount for all, against fairness; equity cannot be measured by the data alone
Measuring and judging	Inequality can be measured; whether it is fair is a value judgement

Why markets produce inequality. Factors differ in ownership and in what the market pays for them: skills, inherited assets, location, luck. Wealth earns income, which builds more wealth.

Why it is market failure. Consumption depends on income and wealth, not on need. Households with low incomes may be unable to afford housing, nutrition, education or healthcare even where the benefit exceeds the cost, so resources flow to what richer households can pay for. Economic welfare depends on the distribution of income and wealth.

Quintile reminder. Country D income shares by quintile: 6%, 10%, 15%, 24%, 45%. The shares add to 100%. Top ÷ bottom = 45 ÷ 6 = 7.5. Top 40% = 24 + 45 = 69%. Bottom 40% = 6 + 10 = 16%.

Evaluation points: equity versus efficiency (incentives), waste of talent under extreme inequality, and the fact that the right balance is a value judgement.

Building an analytical chain

Link each step with “so” or “therefore”, and end on the misallocation.

• Demerit good: consumers underestimate the harm, so private demand is higher than informed demand, so the market quantity is above the desirable quantity, so too many resources go to the good.
• Factor immobility: workers cannot retrain or move, so vacancies and unemployment sit side by side, so output is lost and resources are idle.
• Inequity: low-income households cannot afford high-benefit goods, so consumption follows income and not need, so resources are misallocated.

Quick self-test

1. Define a demerit good.
2. Give the two reasons given for merit goods being underprovided.
3. Perceived demand Qd = 84 − 3P and supply Qs = 12 + 3P. State the market equilibrium.
4. Full-benefit demand is Qd* = 120 − 3P. Find the desirable output and the underprovision.
5. Calculate the net benefit lost in questions 3 and 4.
6. A tablet is worth 900 if good and 300 if poor, and one third are good. What is the most a buyer who cannot tell them apart will pay?
7. A monopolist faces P = 60 − Q with constant marginal cost 12. Find its output, price and profit.
8. Find the deadweight loss in question 7.
9. Price elasticity of demand is −0.25 and supply rises 8%. Estimate the price change and the revenue index.
10. Country D income shares by quintile are 6%, 10%, 15%, 24% and 45%. Find the ratio of the top share to the bottom share and the bottom 40%’s share.

Answers

1. A good that society judges people consume too much of, because of a value judgement.
2. Positive externalities in consumption, and imperfect information that makes consumers underestimate the benefit.
3. P = 12, Q = 48.
4. P = 18, Q = 66. Underprovision is 18.
5. ½ × 12 × 18 = 108.
7. Q = 24, P = 36, profit = 24 × 24 = 576.
9. About −32%; revenue index 0.68 × 1.08 = 0.7344, a fall of 26.6%.
10. 7.5 and 16%.

Where marks are usually lost

• Describing a good as a merit good without saying people undervalue it.
• Treating every externality as proof of a merit or demerit good.
• Labelling one demand curve and not explaining what the second represents.
• Calling monopoly a failure only because profits are high.
• Using the words equal and equitable as if they meant the same.
• Writing about the fix (tax, subsidy, regulation) when the question asks why the market fails.
• Reporting a quintile ratio without saying what it shows or what it cannot show.
• Presenting only one side of an evaluation question and never reaching a verdict.

Official syllabus

Source: the OxfordAQA International AS and A-level Economics specification (9640), version 1.2, from Oxford International AQA Examinations. Covered here: 3.1.5.4, 3.1.5.5, 3.1.5.6.