IGCSE Economics 0455: Demerit Goods and an Indirect Tax on Disposable Vapes

The government of Draymoor is concerned that disposable vaping devices are a demerit good: their price to consumers does not reflect the wider costs they create for the public health system and for the environment.

Before any tax, disposable vaping devices sell for $12.00 each, and 80 000 devices are sold across Draymoor each month.

The government introduces a specific tax of $3.50 on every device sold, which manufacturers pass on in full to consumers. Once the tax takes effect, monthly sales fall to 70 000 devices.

(a) Define a demerit good. [2]

(b) Explain why disposable vaping devices are considered a demerit good, referring to private cost and external cost. [3]

(c) Calculate the new price consumers pay for a device once the tax is in effect, and calculate the monthly tax revenue collected by the Draymoor government at the new quantity sold. [3]

(d) Explain one disadvantage of using this tax, rather than a regulation such as banning sales to under-18s, to reduce consumption of disposable vaping devices. [2]

Part (a): Defining a demerit good

A demerit good is a good that is over-consumed relative to the quantity that would be best for society, because consumers underestimate, or simply ignore, the full costs it creates, costs to themselves in the future, or costs imposed on third parties. As a result, the free market produces and consumes more of the good than is socially optimal.

Part (b): Why disposable vaping devices are a demerit good

The private cost of a vaping device is simply the $12.00 a consumer hands over at the point of sale. This is what the buyer weighs against the private benefit, the enjoyment or nicotine hit, when deciding whether to buy.

However, consuming the device creates costs well beyond this price. Nicotine dependency and lung damage from regular vaping raise the burden on Draymoor’s public health system over time, and improperly disposed batteries and plastic casings create environmental costs (landfill waste, potential chemical leakage). Neither of these costs falls on the consumer at the point of purchase, they are external costs borne by the health system and the wider community.

$\text{social cost} = \text{private cost} + \text{external cost}$

Because the $12.00 price only reflects the private cost, consumers keep buying devices up to the point where their own private benefit equals $12.00, without ever weighing the larger external costs. This means the device is consumed beyond the level that would be best for society as a whole, the defining feature of a demerit good.

Part (c): Calculating the new price and the tax revenue

The tax is passed on in full, so it is simply added to the original price:

$\text{new price} = 12.00 + 3.50 = 15.50$

So consumers now pay $15.50 per device.

Tax revenue is the tax per device multiplied by the number of devices actually sold once the tax is in effect. That is 70 000, not the original 80 000:

$\text{tax revenue} = 3.50 \times 70\,000 = 245\,000$

So the Draymoor government collects $245,000 per month in tax revenue.

Part (d): A disadvantage of the tax compared with regulation

Sales fell from 80 000 to 70 000 devices per month, a drop of only 10 000 devices, even though the price rose by a substantial $3.50, or roughly 29% of the original $12.00 price. Because the fall in quantity sold is proportionately smaller than the rise in price, demand for disposable vapes appears relatively unresponsive: a large share of buyers simply continue purchasing at $15.50 rather than giving up the habit.

This is the disadvantage of a tax as a tool: it raises useful revenue for the government ($245,000 per month), but because many existing users keep buying regardless of price, it does not reliably reduce over-consumption of this demerit good. A regulation such as banning sales to under-18s instead directly restricts access for the group of greatest concern, rather than relying on a price signal that habitual adult users can simply continue to absorb.

Final answers

(a) A demerit good is over-consumed relative to its socially optimal level because its wider costs are not reflected in its price.
(b) The $12.00 price is only the private cost; health-system and environmental costs are external costs not reflected in that price, so vaping devices are over-consumed, a demerit good.
(c) New price = $15.50 per device; monthly tax revenue = $245,000.
(d) Sales fall proportionately less than the price rise, so the tax raises revenue but may not cut consumption as reliably as a direct regulation such as an under-18s sales ban.