The market for merit goods is an example of an incomplete market. Merit goods have two basic characteristics:

Firstly, unlike a private good, the net private benefit to the consumer is not fully recognised at the time of consumption. Net private benefit is the utility from gained from consumption less any private cost incurred, and equates to net consumer surplus. In the case education, which is widely considered to be a merit good, pupils and students cannot possibly know the specific private benefit to them of getting good grades at school, college or university. They will be well aware of the sacrifice required to study, but will not know the benefits to them in terms of a future job, salary, status and skills. Therefore, with education, as with other merit goods, there is a significant information failure in terms of expected benefits.

Secondly, while consumption of a merit good also generates an external benefit to others, from which society gains, this is unlikely to be known or recognised at the point of consumption. Given that decisions to consume are driven by self-interest, it is unlikely that this external benefit will be taken into account when the consumer of a merit good evaluates its worth. For example, an individual student is generally not motivated to study hard in order to benefit others later in life, although everyone associated with them will benefit from their education in some way. Beneficiaries include future employers and all those who consume the products supplied their employer, their family, and friends. The better job they obtain, the more tax they will pay, and the greater the benefit to those who receive welfare benefits and transfers. However, putting a value on these external benefits is impossible, especially at the point of learning.

Healthcare

Healthcare is also regarded as merit good. For example, although it is not possible to know exactly when the benefit will arise, inoculation against a contagious disease clearly provides protection to the individual, and yields a private benefit. There is also an external benefit to other individuals who are protected from catching the disease from those who are inoculated! However, few would choose inoculation simply to protect others!