Markets will tend to over-produce many goods and services that are not in the nation’s best interest. This includes those that should not be produced in any quantities, such as illicit drugs and child pornography, as well as those that are produced and consumed in excessive quantities, such as alcohol or gambling. These goods and services are sometimes referred to as ‘de-merit goods’ and the over-production means that too many resources (such as labour and capital) are being used in the production of these products.
Why is it that markets tend to over-produce these goods? Quite simply, many producers and consumer tend to be motivated by self-interest and greed, leading to undesirable outcomes for society. For example, some producers will still be willing to supply goods and services even though they are fully aware of the harm inflicted on consumers. Dealers of illicit drugs are a case in point and many would argue that the big tobacco manufacturers fall into the same category. This is compounded by the fact that many consumers will be willing to purchase these goods and services knowing too well that they will result in harm to themselves or others, sometimes in the short term, and certainly in the long term.
Markets will also tend to over-produce many goods that have negative effects on the environment. Common examples of this include the excessive pollution or depletion of natural resources that would occur without government controls. Many producers would simply ignore the negative environmental effects of their production by, for example, releasing untreated waste into river systems or oceans, over fishing our oceans, destroying our native forests and emitting too much CO2 into the atmosphere. This is because, in the absence of government intervention, they would not be forced to pay for the negative impacts of their activities.
To overcome these problems with unregulated markets, governments have implemented laws and regulations that seek to change producer and consumer behaviour. Some of the government action involves outright prohibition (i.e. banning) of some production and/or consumption of goods or services. Again, illicit drugs, child pornography and certain firearms are examples, as well as laws related to the control or elimination of many forms of pollution. The government also uses the tax system to manipulate the prices of goods and services in order to change consumer and producer behaviour. For example, the government places heavy taxes, called excise taxes, on tobacco, alcohol and petrol in order to raise prices, reduce demand and limit production.
The carbon tax introduced in 2012 (repealed in 2014) is an example of a government measure that was designed to reduce the production of carbon intensive goods or services (e.g. coal-fired electricity) and encourage the demand for and production of renewable energy. Many de-merit goods are also considered goods with negative externalities in production and/or consumption.