How does the government intervene in the supply and demand of demerit goods ?
By applying the sales tax on the goods
Demerit goods, such as tobacco, alcohol and sugary drinks, are goods whose consumption harms the consumer or society more than individuals realise. Left to the market they are over-consumed, because their negative externalities and long-term costs are not reflected in the price.
To correct this, the government discourages consumption, most commonly by imposing an indirect tax such as a sales or excise tax. The tax raises the price, shifts supply to the left and lowers the quantity demanded, bringing consumption closer to the socially desirable level. Such levies are often called sin taxes.
A tax rebate would make the goods cheaper and encourage their use. Increasing production or increasing consumption would worsen the very over-consumption problem that justifies intervention; those measures suit merit goods such as education and health care, not demerit goods.
By applying the sales tax on the goods option is correct.
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