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Evaluate the view that the most effective way in which the government can discourage the consumption of demerit goods is through government regulations.

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Evaluate the view that the most effective way in which the government can discourage the consumption of demerit goods is through government regulations.

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On the other hand, instead of regulating the market, the government could choose to impose an indirect tax on the demerit good. The effect of an indirect tax on a good is shown by the second diagram, with the supply curve of the good shifting upwards by the amount of the tax from MSC to MSCtax. This leads to a lower quantity supplied at every price level, and a new equilibrium with a higher price and a lower quantity demanded. This also achieves the government's aim of reducing the consumption of the good to reduce the deadweight loss and thus market failure created by the demerit good. Furthermore, on top of reducing the consumption of the demerit good, an indirect tax would allow an extra source of revenue for the government.

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Therefore, the goal of the government, whether by regulations or other forms of intervention such as indirect taxes or price floors, is to reduce the quantity consumed of the demerit good, in order to achieve maximum social surplus. Regulations that limit the consumption of demerit goods would shift the demand curve inwards, leading to a lower quantity demanded at every price level. This shift of the demand curve from MPB to MPBgov (as shown by the second graph), leads to a contraction along the supply curve, and thus a new equilibrium, where there is a lower price and a lower quantity sold, effectively reducing the consumption of the demerit good.

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Therefore, though government regulations can be effective in reducing the consumption of demerit goods which helps to reduce the market failure associated with these goods, there are other alternatives such as imposing an indirect tax on the demerit good, which can prove to be equally effective, while also contributing to government revenue which could be further used to reduce market failure in other markets.

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As seen from the top graph, since the demerit good has higher MPB than MSB, there is an oversupply and overconsumption of the good in the market. The socially optimum price and quantity is P* and Q* respectively, determined by where MSB = MSC, leading to maximum social surplus.

Since demerit goods, such as cigarettes, alcohol and drugs tend to have an inelastic demand

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Demerit goods are goods that are seemingly undesirable to consumers as they have negative externalities of consumption on society, with their marginal social benefits being lower than their marginal private benefits. Government regulations is a form of legal intervention by the government, such as imposing laws, on a free market in order to reduce market failure.