Economic theory predicts that while markets may form to supply some merit goods, total supply will be insufficient to achieve asocially efficient level of consumption. A number of factors explain the lack of merit goods in a free market economy.

There is a significant level of information failure, in terms of both the private and the external benefits resulting from consumption of merit goods. For example, there is likely to be considerable information failure in terms of recognising the benefit to themselves, and to others, of regular health checks, eye tests, or visits to the dentist.

There may also be considerable time lags in deriving the benefit of a merit good. This is clearly the case with education, where the private benefits may not occur for ten or twenty years after consumption.

Given that individuals are driven largely by self-interest, the external benefit of consuming a merit good is not likely to be included in the private calculation of buyers and sellers. However, society needs as many people as possible to be educated and healthy so that all individuals can receive the maximum external benefit.

Finally, individuals and families on low incomes are not likely to be able to pay the full market price of merit goods, and will under-consume. For example, to continue to supply private education, tuition fees must be set to cover the full costs of supply. However, private fees are likely to be well in excess of what many low income families could afford to pay.

Because of the above, it is likely that merit goods will be under-consumed and under-supplied.

In a free market, the supply curve reflects marginal private cost (MPC), and the demand curve reflects the marginal private benefit (MPB), or utility, expected from consumption.

However, the expected marginal private benefit is likely to be much greater than the actual benefit. This is because individual consumers of merit goods fail to perceive the true benefit to them. Indeed, there is an information failure, which results in the consumer under-consuming.

Hence, on the graph, the actual marginal private benefit is higher, and to the right of the expected benefit curve.