Why the market under-consumes merit goods and over-consumes demerit goods: information gaps and externalities together, the demerit good diagram with MSB below MPB, the welfare loss, and tax, regulation and information as remedies. Through the vaping duty.
On 1 October 2026 the UK introduced Vaping Products Duty: £2.20 on every 10ml of vape liquid, with or without nicotine, on top of VAT. The Treasury said the aim was to reduce the affordability and appeal of vaping, especially to young people and non-smokers, while raising tobacco duty by an extra £2.20 per 100 cigarettes on the same day so that cigarettes stayed dearer than vapes. Disposable vapes had already been banned in June 2025.
Vaping is legal for adults. For a smoker, switching to vapes reduces harm. The government is not trying to ban it. It is trying to make people consume less of it than they would choose to, and it is using a price to do so.
Why does the market produce too much of some goods and too little of others, even with no monopoly and no missing market?
Source: HM Revenue and Customs, “New Vaping Products Duty comes into effect”, press release, 1 October 2026; HM Treasury policy paper, 26 November 2025.
A merit good is one that is under-consumed if left to the market, because consumers under-value the benefit to themselves and ignore the benefit to others: education, vaccination, health check-ups, pensions.
A demerit good is one that is over-consumed if left to the market, because consumers under-value the harm to themselves and ignore the harm to others: cigarettes, vapes, alcohol, gambling, sugary drinks.
Two failures act together. An information gap: people misjudge the private benefit or harm, often because the effects are long-term and the pleasure is now. An externality: some of the benefit or cost falls on third parties, such as the NHS. On the diagram both appear as a gap between the benefit consumers act on, MPB, and the true benefit to society, MSB.
The judgement that a good is a merit or demerit good is partly normative: someone has to decide that people are wrong about what is good for them.
From 1 October 2026 every 10ml of vape liquid sold in the UK carries £2.20 of duty.
Vapes are legal for adults, and for a smoker who switches they are less harmful than cigarettes. So why tax them?
What is the best economic case for the duty?
Vape liquid is a demerit good: consumers, especially young ones, under-value the harm to themselves, and some of the cost falls on others through the NHS. Both mean too much is consumed. A tax raises the price towards the true cost.
Take vape liquid. Supply is the marginal private cost, and with no production externality it is also the marginal social cost: **S = MPC = MSC**. Demand is the benefit consumers think they get, **MPB**. The market settles where they meet: Q1 units at price P1. In a free market, that is what gets consumed.
Check: Which of these is the best example of a demerit good?
Smokers under-value the long-term harm to themselves and impose costs on others. Vaccination is a merit good, a lighthouse a public good, bread a normal private good.
Now the true picture. The benefit to society of each unit, MSB, is lower than MPB. The gap has two parts: the harm to the user that they discount or do not know about, and the cost to others. On a merit good diagram the gap runs the other way, with MSB above MPB. Here, for a demerit good, MSB is **below** demand.
Teacher tip: Some textbooks put the demerit good gap on the cost side (MSC above MPC) and treat it as a consumption externality. Either is accepted by examiners if it is labelled and explained. This lesson puts it on the benefit side, because the failure is in what consumers think they gain.
Check: For a demerit good, MSB lies below MPB because:
The true benefit to society is less than the benefit consumers act on: part of the gap is harm to themselves they discount, part is cost to others.
The social optimum is where MSB = MSC, at Q*, to the left of Q1. The market over-consumes by Q1 − Q*. Every unit in that range is worth less to society than it costs to produce. The information gap and the external cost together push consumption past the point where it should stop.
Check: The social optimum is at Q*, where:
Society should consume up to the point where the true benefit of the last unit equals its true cost.
The welfare loss is the triangle between MSC and MSB from Q* to Q1. It points towards the social optimum, as it does on every externality diagram. At Q1 the loss on the last unit is the full gap between the two curves; at Q* it is zero.
Check: On this diagram the welfare loss from over-consumption is the triangle:
For the units between Q* and Q1, cost to society (MSC) exceeds true benefit (MSB). Summing the gap gives the triangle, pointing at Q*.
The first remedy: an indirect tax equal to the gap. It shifts supply up to S + tax. The new equilibrium is at Q*, with consumers paying P2 and producers receiving P*. The vaping duty, tobacco duty, alcohol duty and the soft drinks levy all work this way: price in the harm the consumer ignores.
Check: To move consumption from Q1 to Q*, a per-unit tax should equal:
A tax of that size raises the supply price so that MPB meets S + tax at Q*: consumers now pay the true social cost of the last unit.
Other remedies. Regulation: age limits (18 for vapes and cigarettes), the disposable vape ban, advertising bans, plain packaging. Information: health warnings, campaigns, so MPB shifts down towards MSB and the gap itself closes. For merit goods the mirror image: subsidies, state provision (free schooling, free vaccines) and compulsion (education to 18).
Check: Which policy works by shifting MPB towards MSB, rather than by changing the price?
Information changes what consumers believe about the benefit or harm, so the demand curve itself moves towards the true benefit.
MSB is drawn above MPB. That is the merit good case: society gains more than consumers think. For a demerit good the true benefit is lower, so MSB lies below MPB and Q* is to the left of Q1.
Using a diagram, explain why demerit goods such as vapes are over-consumed in a free market, and evaluate the use of an indirect tax to correct this.
A demerit good is one that is over-consumed if left to the market because consumers under-value the harm it does to themselves and ignore the cost it imposes on others. Vape liquid is an example: users, especially young ones, discount long-term harm, and some of the cost of treating that harm falls on the NHS.
On the diagram supply is S = MPC = MSC, since there is no production externality. Demand is the benefit consumers act on, MPB. The true benefit to society, MSB, lies below MPB; the vertical gap is the harm consumers ignore plus the cost to others. The market settles where MPB = MPC, at Q1 and P1. The social optimum is where MSB = MSC, at Q*, to the left. Every unit between Q* and Q1 costs society more than it is worth, so the market over-consumes and the welfare loss is the triangle between MSC and MSB from Q* to Q1.
An indirect tax equal to the gap at Q* shifts supply up to S + tax. The new equilibrium is at Q*: consumers pay a higher price P2 that reflects the true social cost of the last unit, producers receive P*, and the welfare loss is removed. The Vaping Products Duty of £2.20 per 10ml, introduced in October 2026, is such a tax.
**However,** nicotine is addictive, so demand is price inelastic: the tax raises revenue but cuts consumption by less than the diagram suggests, and the burden falls hardest on poorer households who vape more. The government cannot measure the gap precisely, so the rate is a judgement. Set too high, the tax creates a black market in untaxed liquid, as high tobacco duty has for cigarettes, and it risks pushing vapers back towards cigarettes if those are not kept dearer, which is why tobacco duty rose on the same day. A tax works best alongside information and regulation, such as age limits and the disposable vape ban, which shift MPB itself towards MSB. On balance a moderate tax is justified, but it corrects the externality more convincingly than the information gap, which needs policies that change what people know.
Vaping Products Duty: HM Revenue and Customs press release, 1 October 2026, and the policy paper of 26 November 2025. The numbers on the diagram are for an invented market, chosen so the arithmetic is clear. Diagrams drawn with Rough.js and perfect-freehand, both MIT licensed.