Government Policies that May Reduce Consumption and Production of Demerit Goods - Essay Example

Government policies that may reduce consumption and production of demerit goods Government policies that may reduce consumption and production of demerit goods Demerit goods are products that have negative effects on consumers. The products also pose harmful externalities and exude negative externalities. It means that the third parties incur the costs or the effects of consuming them. The reasons for consuming demerits goods include lack of awareness on their negative effects or consumers’ poor decision-making capabilities. An example of such a good is alcohol. It affects the health of consumers negatively. In addition, consumption of alcohol can affect other people. For example, high consumption of alcohol by individuals can increase the rate of crime, eventually, affecting the whole society. Consumption of alcohol by teenagers also makes their parents incur huge medical expenses when the teenagers get sick. Demerit goods can be over consumed in a free market (Kohls 2003, p. 54). It is important to note that a factor that may lead to individual overconsumption is the lower cost of production because the costs are shared with third parties. People also consume more goods compared to what the society produces due lack of regulations that may restrict them. Approaches to Reduce Overconsumption Overconsumption can be reduced with government interventions. For instance, the government can intervene using the market-based approaches such as taxes and subsidies (Owen 2004, p. 128). It can also intervene through command and control strategies such as regulations. Awareness programs and persuasion can also be used to reduce overconsumption and overproduction. Market Based Approaches The government may impose taxes on demerit goods in order to internalize the externalities caused by the goods. It may impose the taxes indirectly on the organizations. For example, a firm that releases pollutants in a river may be taxed. The tax imposed on such firms should be equal to the external costs incurred by third parties. The external costs incurred by the third party may include medical bills resulting from taking the polluted water from the river. This means that the harms caused by the pollutants produced by the firm are the externalities (Kazi 2008, p. 410). In order to tax such firms effectively, the government should ensure that the taxes imposed on the firms are equal to the harm. The process will discourage them from producing the pollutants because the cost of production for the company will increase (Grant & Vidler 2003, p. 76). In addition, firms will be hindered from producing large quantities of goods that harm the health of individuals. This will in turn help in reducing the quantity of demerit goods produced by the taxed companies. For companies that produce alcohol, the government may intervene by making the firms pay taxes that are equal to the marginal external cost. Tax policy will be helpful in making the firms reduce harms to an optimum level. The method is a source of revenue to the government. The government would then use the revenue to provide other important services like education, health and pay civil servants. In addition to this, it allows market forces such as factors affecting demand, price and supply to apply. The problem with this method is that customers can easily switch to substitutes. In addition to this, if the good is luxurious, consumers may not mind paying more as long as they access the good. Other customers may continue consuming the good regardless of the change in price because they have a higher level of income and have allocated enough money for the good. Lastly, the system may discourage potential investors because of high cost of production (Grant & Vidler 2003, p. 80). Tax Diagram Even though taxes may help in reducing externality, it may also be inefficient. For example, it may lead to elimination of incentives on consumption and production of goods. This may result into lower productivity of companies (Grant & Vidler 2000, p. 106). For example, if the high marginal rate affects people’s incomes, it may discourage them from working harder. It is likely that they will be taxed more if their income increases. The situation can also lead market failure. In addition, taxation may increase the cost of living for poor families. For instance, if the government imposes huge taxes on fuel used at home such as kerosene, poor families using kerosene as the main source of cooking energy may feel the effects of taxation. Subsidies The government may also intervene by using subsidies that should be given to companies whose products have external benefits. The subsidies will enable the companies to produce more goods in the market. For instance, if a firm deals with production of organic foods, the government should equate the subsidies offered to the company with the benefits acquired after consuming the organic foods. The condition will reduce the cost of producing the organic foods. This will in turn encourage the firms to produce more goods. It will also help in reducing negative externalities in various ways (Estaban & Dinar 2013, p. 444). For example, it may lead to stiff competition between companies producing organic and those produce similar products that are inorganic. Since the ones that produce organic foods incur lower costs due to subsidies, they may reduce the prices of their goods. The strategy will enable them attract more consumers in comparison to firms dealing with inorganic products. As illustrated in the diagram, the MPC is equal to MPB with the absence of government intervention in the market. However, the government intervention using subsidies increases the distance between MSB and MPB. The distance should be the same as the benefits acquired from the company’s products. It means that the government subsidies will increase the MPB if more people consume the goods of firms that produce positive externalities (Killora & Kelly 2010, P. 136). This is the most effective way of curbing under-consumption because it is easy to implement. In addition to this, the method would ensure the low-income earners access quality goods and services that they would otherwise not access due to their high cost. However, just like taxes, EB valuation is difficult. The government may also find it hard to implement the policy because it is expensive (Killora & Kelly 2010, P. 140). Subsidies Diagram In as much as subsidies will help in reducing the amount of demerit goods consumed, it has numerous inefficiencies. For example, it may lead to elimination of some companies in the market. It may lead to unhealthy competition and inequality in the market. For instance, companies that produce positive externalities may attract more consumers compared to similar companies that do not enjoy subsidies. This may lower their market shares or eliminate them from the market. This may have negative impacts on the economy of the country. In addition, the subsidies strategies may fail due to political reasons. For example, politicians may decide to give some firms subsidies in order to satisfy their selfish interest instead of the society’s interests. This may encourage fraud in the market (Gillespie & Gillespie 2001, p. 25). Minimum prices Setting of minimum prices by the government will also help in reducing the production and consumption of demerit goods. Most people consume products such as cigarettes because they do not care about their personal costs. In addition, addiction to such substances forces many people to buy them (Lipsey & Harbury 2004, p. 23). However, such products negatively affect other people through second hand smoking. It is important for the government to intervene by setting minimum prices for such products. This will discourage many consumers from buying the products. High prices will also reduce demand for the goods that will in turn make producers to reduce the amount of their products. Without setting the limit prices for such goods, some companies may set very low prices that will attract many consumers. Setting price limit for demerits goods may have negative impacts. For example, it may lead to inequality in goods consumption because wealthy people in the society will consume the goods regardless of the price (Joonas 2004, p. 196). This is usually seen when the government sets high alcohol prices. The wealthy individuals in the society will still go for the high quality alcohol brands while the poor turn to poor quality alcohol brands that negatively influence their health. In addition, price increases the cost of living for individuals who use certain products because they do not know their effects or are addicted to them. Command and Control Measures Laws and Regulations The government may also intervene by regulating business activities in order to reduce the negative externalities through laws. For instance, the government may set time limits for selling certain products to consumers. This mostly applies to firms that produce alcohol. The government may limit the time or duration for sell of alcohol to consumers. For example, it may restrict businesses to sell alcohol before a specific time in the evening (Cullis & Jones 2009, p. 13).. This will help in reducing the number of people taking alcohol and the amount of time consumer takes the product In addition, the government may introduce laws that prohibit businesses from increasing external costs (Sartzetakis & Tsigaris 2005, p. 309). The laws prohibit firms from disposing wastes in water bodies. The law may prohibit firms by setting huge penalties for the companies that dispose wastes in water bodies. It may also force companies that have the potential of polluting rivers to stop it charging them so that the money can be used for proper waste disposal. Such costs make companies to bear all external costs. It also makes them to reduce or avoid activities that increase externality costs The laws and regulations may have negative impacts on the economy because it reduces the productivities of many companies. It addition, it will increase unemployment rates since regulated operating workers will reduce the amount of work in the businesses. This will make many people to lose their jobs (Hori 2011, p. 30). It may also discourage potential investors who may cite government interference in running businesses. In addition to this, banning production of some goods may result into legal battles between firms and government. Lastly, the government may find it hard to enforce the legislations in a free market (Hori 2011, p. 34). Nationalization This refers to the process of taking over ownership of industries by the government. The companies foregoing their business may or may not be compensated. The government has various reasons for nationalizing some industries (Lipsey & Harbury 2004, p. 39). One of them could be to control production of demerit goods. It can also be away of expanding its economic resources, correcting market failure and misallocation of resources. Most firms operate businesses with a single aim of making profits. They do not consider the impact their goods have on the environment or those who consume. For example, vodka companies are only after profits they make and expansion of their businesses without putting in mind their product cause liver cancer. In addition to this, alcohol is associated with domestic violence and divorce. Airline firms do not care about the hospital and school they fly over nor the noise polluting the environment. This calls for nationalizing of such firms in order to protect the consumers and others affected by their services. Nationalizing of industries thus allows the government to correct those market failures (Lipsey & Harbury 2004, p. 55). Nationalizing compels firms to pay for externalities. As result, government and individuals are not forced to pay for them. For example, in case of cigarettes, any excise tax and VAT given to the government would be channeled to production of merit goods and services like health centers and hospitals. As result, though smoking is harmful, the firms are funding the treatment of those complications effectively (Lipsey & Harbury 2004, p. 90).  Nationalization also allows the government to regulate the supply of demerit goods. This allows the government to decide how much demerits goods like alcohol can be released to the market. The government can also use that opportunity to compel organizations to compensate victims associated with consumption of demerit good from a particular nationalized firm. The government can also use the taxes collected from nationalized companies to subsidize production of merit goods. In addition to this, it is easy to control nationalized companies than privatized ones. This is because the government can closely monitor those firms and verify the quality of goods produced before releasing them to the market (Lipsey & Harbury 2004, p. 120). Tradable Permits Tradeable permits are effective way of reducing pollution and demerit good. The government sets a quota of the amount of pollution in the environment. The government then sells the shares of these quotas to companies. Any company that exceeds its quota, it would be compelled to pay the government (Sartzetakis & Tsigaris 2005, p. 409). The government can then use the money collected to maintain the environment and compensate those affected by the pollution. If a firm reduces its pollution level, it can sell its quota to another firm willing to pollute the environment at a fee. Tradable permits are sure ways to manage demerit goods because they combine taxation and regulation elements to correct market failures. The system is better than regulation because it encourages firms to reduce pollution through incentives. In addition to this, it allows the government to earn some revenue that is channeled to other areas of economy. The system is also good to regulate demerit goods if price is inelastic. This is because any increase in price due to increased taxation would be passed to consumers. However, the method is effective only if the government has accurate information. For example, it might be difficult to measure quantity of externality. They would eventually hinder the calculation of permits to issue. In addition to this, if the government offered too many permits, the level of pollution would go up while if they offer less permits, the price of commodity would be too high (Sartzetakis & Tsigaris 2005, p. 459). Information/education/persuasion The government can also reduce the production and consumption of demerit products through education programs. This can be done through awareness programs where the government educates citizens about the losses they incur by consuming demerit goods. The process will help in discouraging people from using certain products especially when they lack enough information about the products. Education will also help in encouraging consumers to use goods that have positive externalities. The government may also persuade consumers to stop using certain products through mass media (Lin 2004, p. 20). The ineffectiveness of education or awareness programs may be the high costs incurred by the government. For instance, effective implementation of awareness programs will force the government to employ more people and allocate resources for the programs. The condition may be worse if the targeted population lives in remote areas. In addition, the government may mislead people if it fails to acquire enough information about the negative externalities (Kerr, Milne, Chhotray et al 2007, p. 263). Lack of information is one reason why consumers consume demerit goods. It is therefore important for government to provide the required information in order to correct market failures. In most cases, laws and regulations accompany these information and campaigns. The government also ensures that organizations label their goods and provide the relevant information about any effects of the product on consumers. For example, the organizations should indicate if the products have health effects like damaging the liver or causing cancer. This would equip consumers with accurate, current information on the quality of goods they consume. As such, consumers would make informed decisions when purchasing demerit goods (Lin 2004, p. 25). Economists believe that lack of information has compelled consumers to purchase products that have harmful effects on them. Producers also use persuasive marketing strategy that results in consumption of demerit goods. For example, some alcohol firms might write on their products misleading messages. This would encourage several consumers to purchase the demerit product regardless of the harmful effect it would have on them (Lin 2004, p. 30). The government should also sensitize its citizen on major areas that they are likely to find demerit goods. For example, the government can create a web that lists various demerit goods. Consequently, consumers would be able to avoid such goods. It should use experts in various fields who have a wide knowledge to sensitize individuals on demerit goods. For example, it can use the ministry of health to sensitize the public on any fake drugs in the market. It can also use environmentalists to educate the public on danger of purchasing lead petrol, which would pollute the environment (Kerr, Milne, Chhotray et al 2007, p. 269). In the event that measures are all put in place, the purchase of demerit goods would decline. The labeling of cigarettes and alcohol packages with health warning signs would reduce drinking and smoking. In addition, good nutritional information on food would discourage purchasing of junky, fast and fatty foods that encourages obesity. Lastly, television advertisement on anti-speeding and drunk driving would discourage drivers from consuming large amount of alcohol (Kerr, Milne, Chhotray et al 2007, p. 274). The measures are designed to alter the “perceived” benefits and costs of consumption for the customer. The measures do not have direct influence on market prices. However, they influence demand that in turn affects supply and consumption. However, the system may not be productive because time and funds are needed to run such programs. In addition to this, business may counter such moves with massive advertisement and propaganda (Kerr, Milne, Chhotray et al 2007, p. 290). Conclusion Conclusively, high consumption and production of demerit goods in free market leads to market failure through high external costs. Government intervention through policies will help in solving the problem. The government can intervene by imposing taxes on companies that produce negative externalities while encouraging firms that produce positive externalities through subsidies. It can also intervene through awareness creation programs in order to educate consumers about the positive and negative impacts of certain products. The government should ensure that politics do not interfere with the interventions. It should also ensure that the benefits of the interventions outweigh costs. Control of demerit goods should not be left to the government alone. This is because the government can come up with a policy that might harm other business. It would be advisable for all stakeholders to join hand and come up with policies that would limit production of demerit goods. Firstly, organizations that produce demerit goods should try to limit the impact those goods could have on consumers. In addition to this, they should notify consumers of any dangers related with the consumption of those goods (Owen 2004, p. 135). Customers should also avoid demerit goods because they might have severe effects on their health. Lastly, the government should hold anyone responsible for producing demerit goods that would harm consumers. List of References Cullis, J. G., & Jones, P. (2009) Public finance and public choice: Analytical perspectives, Oxford: Oxford University Press. Esteban, E., & Dinar, A. (2013) Cooperative management of groundwater resources in the presence of environmental externalities. Environmental and Resource Economics, 54(3), Gillespie, A., & Gillespie, A. (2001) AS & A level economics through diagrams, Oxford: Oxford University Press. Grant, S., & Vidler, C. (2003) Heinemann economics for OCR, Oxford: Heinemann Educational. Grant, S., & Vidler, C (2000) Economics in context, Oxford: Heinemann. Hori, T. (2011) the effects of consumption externalities in an R&D-based growth model with endogenous skilled and unskilled labor supply, Journal of Economics, 102(1), 29-55. Joonas, K. A. (2004) An empirical investigation of a model of environmentally concerned consumer behavior and its determinants: The moderating role of market mavenship and product involvement: ProQuest Dissertations and Theses, Vol 1: 196-196. Read More