Public Good versus Demerit Good, and Policies for the PMD Market

Answer

Part (a) — Differences between a public good and a demerit good [10]

A public good and a demerit good fail the market in fundamentally different ways: the first is a missing-market problem rooted in the nature of the good, the second an over-consumption problem rooted in externalities and misinformation about an ordinary private good.

Rivalry in consumption. A public good is non-rivalrous: one person’s consumption does not reduce the amount available to others, so the marginal cost of serving an additional user is zero. A profit-maximising firm producing where $MR = MC = 0$ cannot charge a positive price, so it has no incentive to supply. A demerit good is a private good and is rivalrous: each unit consumed is unavailable to others, the marginal cost of an extra user is positive, and the firm can charge a price covering that cost — so production is viable.

Excludability. A public good is non-excludable: once provided, no one can be prevented from benefiting, so consumers free-ride and no effective demand is revealed; the market fails completely and the good is not provided at all. A demerit good is excludable — non-payers can be denied — so a market exists and the good is traded; the failure is not that it is unprovided but that it is over-consumed.

Source and direction of market failure. Public goods fail because their characteristics prevent any market forming — the welfare loss is the entire net benefit foregone. A demerit good (cigarettes, and by analogy reckless PMD use) is one the government judges socially undesirable and which, left to the price mechanism, is over-consumed — because it generates negative externalities and/or because consumers, through imperfect information, underestimate its private costs. The failure is over-allocation relative to the social optimum, not the absence of a market.

Part (b) — Policies for a more efficient allocation in the PMD market [15]

The PMD market fails on two counts: over-usage on footpaths and roads imposes a negative externality (injury and death to third parties), and riders, through imperfect information, under-perceive the private risk. The result is consumption above the social optimum and a deadweight welfare loss.

Policy 1 — an outright ban: effective but blunt. A ban drives usage on roads and footpaths to zero, eliminating the externality from those locations. The objection is that it over-corrects: if there is a positive net social benefit to PMD use up to Qs (MSB > MSC over 0 to Qs), banning all use forfeits that benefit and may create a larger deadweight loss than the original failure — a case of government failure. It also penalises considerate riders, requires costly enforcement and monitoring (with an opportunity cost in foregone spending on transport, education or healthcare), and demands information on the intangible costs of accidents that is hard to monetise in order to set proportionate penalties.

Policy 2 — education and public information: targets the root cause but slow. Since part of the failure is imperfect information, a campaign correcting riders’ under-perception of risk shifts perceived private cost toward actual private cost, lowering usage toward the optimum without banning a beneficial activity. Its advantages are that it is non-distortionary and preserves the gains from responsible use; its weaknesses are that it works only gradually, depends on riders responding to information, and cannot internalise the externality imposed on others (which information to the rider does not directly price).

Policy 3 — regulation short of a ban / market-based correction. Intermediate measures — licensing, speed and weight limits, designated paths, or penalties calibrated to the marginal external cost — aim to cut usage to Qs rather than to zero, internalising the externality while retaining beneficial use. These are more efficient in principle but information-intensive: setting the right standard or charge requires knowing the size of the external cost.

Judgement. No single policy is unambiguously appropriate. A ban is the most certain way to stop the harm but the least efficient, risking government failure by destroying net social benefit and imposing high enforcement costs; education is efficient but slow and incomplete; targeted regulation is the most economically apt but the hardest to calibrate. The appropriate response is therefore a combination — education to address the information failure, alongside calibrated regulation (and a ban only on the most dangerous uses) to internalise the externality — with the weighting determined by the magnitude of the external cost, the responsiveness of riders, and the government’s capacity to enforce. Where the harm is severe and information poor, as the surge in accidents suggests, the case for firm regulation backed by enforcement is strong, but it should aim at the social optimum rather than at zero.