ILP: Sources Of Market Failure in the American Healthcare System

Background Research:
Healthcare expenditures have been rising for developed countries, most notably in the United States (U.S.). According to the World Health Statistics 2008, U.S. spends more on healthcare per person than any other nation in the world, at over US$7000 per head, but is ranked only 72nd in terms of overall healthcare quality. The discussed market in the U.S. has failed to deliver a socially efficient allocation of resources to provide healthcare, resulting in market failure.

Some factors that contribute to the healthcare market failure include positive externalities like underproduction of merit goods and imperfect information.

(i).Positive externalities – Underproduction of merit goods (Healthcare)

Assume that External Marginal Cost (EMC) = 0 (no costs spilled over to third parties). Thus, SS = PMC = SMC. Private Marginal Benefit (PMB) is the improvement in one’s health and Private Marginal Cost (PMC) is the cost incurred by healthcare providers. The market equilibrium outcome, when there is no government intervention, is Q0, where PMB = PMC.
However, due to positive externalities of healthcare (EMB), including a reduced risk in others contracting the same diseases and a minimised burden on families of the sick, SMB (EMB + PMB) lies above PMB. In other words, it suggests that the allocatively efficient output should be QSE where SMC = SMB and not Q0. Healthcare providers do not provide sufficient quantities of such a merit good as there are substantial amount of external benefits that come along with it. As a result, there is an underconsumption of Q0 – QSE. The government intervenes by subsidising healthcare costs. Despite the intervention’s ability to increase provision of healthcare, it reduces incentives for providers to seek the lowest cost of production. Physicians fearing consequences take highly visible but unnecessary precautions such as ordering tests beyond the level desired by patients given their insurance coverage, with expected benefits greater than costs, only to end up with higher healthcare expenditures. Hence, health care expenditures grow. Consequently, subsidies increase providers’ profits as a comparatively smaller proportion of subsidised cost is passed on to the consumers, causing income inequality.

(ii). Imperfect information (uninformed buyer)

· Asymmetric information (Uninformed buyers and knowledgeable sellers): In the healthcare market, patients often have poor knowledge about what medicine is suitable in treating their conditions. Since doctors are relied upon to give diagnosis, corrupt doctors might advise more expensive or higher-level treatment and diagnostic procedures than that is necessary to obtain greater profits. Due to the fragmented healthcare provider practice in the U.S., doctors might not fully understand the patients’ medical condition and history and prescribe cost-ineffective or unnecessary treatment.

· Incomplete information: Private medical insurance contributes significantly to the market failure. It can occur when consumers and providers do not have identical information about the price, quantity or other aspects of the insurance plans. Consumers may unknowingly buy insurance plans that are too expensive or unsuited to cover their medical expenses. Patients might not be given certain treatments due to gaps in their insurance coverage.

References:

• (2009, March, 5). Barack Obama. The Economist, Retrieved 4 April,2009, from http://www.economist.com/displayStory.cfm?story_id=13235460
• Committee on the Consequences of Uninsurance, (2004). Insuring America: Principles and Recommendations. USA, Washington D.C.: The National Academies Press.
• (2006). OECD Health Data 2005: How Does The United States Compare. Retrieved April 5, 2009, from Organisation for Economic Co-operation and Development (OECD) Web site: http://www.oecd.org/dataoecd/15/23/34970246.pdf
• Conover, Christopher J. (2004, October 4). Health care regulation: A $169 Billion Hidden Tax. CATO Institute, 527, Retrieved April 9, 2009, from http://www.cato.org/pubs/pas/pa527.pdf
• Hacker, Jacob S. (2007, January 11). Health care for America. Retrieved April 12, 2009, from Economic Policy Institute Web site: http://www.sharedprosperity.org/bp180.html

Research By: Bernice Lin, Yuen Kit Kuan

Post By: Yuen Kit Kuan