What is demrit goods:
A demerit good is a product or service that is harmful to individuals and society, but people may overconsume it due to a lack of awareness about its negative effects. Governments often try to reduce consumption of demerit goods through taxes, regulations, or public awareness campaigns (e.g,: gambling and alcohol).
How Higher Indirect Taxes Reduce Market Failure:
Increases Prices, Reducing Demand – Taxes make demerit goods (e.g., cigarettes, alcohol, sugary drinks) more expensive, discouraging consumption.
Internalizes Negative Externalities – Consumers pay a price that reflects the social costs (e.g., healthcare costs, environmental damage).
Raises Government Revenue – Funds collected from taxes can be used for healthcare, awareness campaigns, or subsidies for healthier alternatives.
Limitations of Indirect Taxes on Demerit Goods:
Inelastic Demand – Many demerit goods (like cigarettes and alcohol) have low price elasticity, meaning people continue to buy them despite higher prices.
Black Market Growth – Excessive taxation may encourage illegal trade and smuggling, reducing government control.
Regressive Impact – Higher taxes can disproportionately affect low-income individuals, as they spend a larger share of their income on taxed goods.
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