Chapter 16

Government Intervention in
Healthcare Markets
 After mastering this material,
students will be able to
 describe the advantages of markets,
 explain when markets may fail, and
 discuss responses to market failures.

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 Markets can
 assemble information about value
– reliably, and
– efficiently;
 align production and consumption
– from most efficient producers,
– to consumers who value product most.

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 Advantages of Markets
 Dynamic efficiency
– Punish producers of unwanted products
– Reward producers of wanted products
– Reward imitators of successful products
– Reward innovators

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 Reasons for Market Failure
 Externalities
 Public goods
 Imperfect competition
 Imperfect information
 Natural monopoly
 Income redistribution

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EXTERNALITIES
AND PUBLIC GOODS
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 Externalities
 Externalities occur when production or
consumption of a product directly affects
someone else.
 If the effects are not fully considered in the
market, market equilibrium will be
inefficient.

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 Externalities can be
positive or negative.
 Positive
– Your immunization improves my health.
– Your research improves my care.
 Negative
– Your overuse of antibiotics makes my bug
resistant.
– Your illness infects me.

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 Market equilibrium will be
inefficient.
Social
Socially efficient outcome

S
P
B

Private

Q Private Q Social Q

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 Public goods
are extreme externalities.
 Consumption by one person does not
prevent consumption by another.
 It is impossible to prevent anyone from
consuming the product.
 Examples
– Standard radio broadcast
– Reductions in air pollution

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 Public Goods

Efficient Quantity
A+B+C
Market Quantity
W
T Cam
P
MC

Alex Bailey
Quantity of Public Good

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 Public Bads

D
Efficient Quantity
MSC
W
MC
T
P

Market Quantity

Quantity of Public Bad

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INCOMPLETE OR
UNCOMPETITIVE MARKETS
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 Imperfect Competition
 In imperfectly competitive markets
– prices will be higher than marginal cost (MC), and
– consumption will be too low.

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 Imperfect Information
 Consumers may overstate
– cost and consume too little, or
– benefit and consume too much.
 Or, consumers may understate
– cost and consume too much, and
– benefit and consume too little.

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 Incomplete Markets
 Some beneficial trades cannot be made.
 Often these are financial markets.
– Insurance
– Credit
 Health insurance is a prime example.

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 Incomplete Health Insurance
Markets
 Individuals
– want to buy insurance,
– can afford to buy insurance,
– but cannot buy it.
 Insurers
– do not know how risky clients are, and
– fear that only high-risk clients will apply.

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 Natural Monopoly
 Nature of production
– Large fixed costs
– Low incremental costs
– Declining average costs
 Only one producer may be viable.
– Hospital
– Some drugs

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 Natural Monopoly
 Prices are likely to be very high.
 Too little will be sold.

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 Income inequality can result
in market failure.
 Inability may preclude good investments.
– Healthcare and nutrition
– Education and housing
 Inequality may have external effects.
– Because of moral objections to poverty
– Because poverty increases disorder
– Because poverty reduces growth

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RESPONSES
TO MARKET FAILURE
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 Responses to Market Failure
 Property rights assignments
 Taxes and subsidies
 Public provision
 Regulation

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 Property Rights Assignments
 Externalities may reflect unclear ownership.
– Rights can’t be bought or sold.
– Value may be ambiguous.
 Assignment of rights may solve this.
– Assignment to individuals
– Assignment to government

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 Taxes and Subsidies
 In principle, these could remedy
– external benefits, and
– external costs.
 In practice, setting these taxes is hard.

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 Taxes and Subsidies
 Progressive taxes
– Higher rates for high-income people
– Tax credits for low-income people
 Progressive benefits
– Higher benefits for low-income people
– Benefit means testing
– Minimum benefit levels

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 Public Provision
 Common for public goods
– Public health activities
– Research
 Need not mean public production
– Private universities conduct research
– Private insurers run public programs

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 Regulation
 Discussed in detail in Chapter 17
 Commonly used
 May work well or poorly

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CONCLUSIONS

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 Conclusions
 Markets have many virtues.
 But they sometimes fail.

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 Reasons for Market Failure
 Externalities
 Public goods
 Imperfect competition
 Imperfect information
 Natural monopoly
 Income redistribution

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 Sometimes markets
give efficient outcomes
 but the results are unacceptable.
– Homelessness
– Deaths and disability from treatable illnesses
– Large numbers without education

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 What should be done
when markets fail?
 Nothing?
 Reassign property rights?
 Taxes or subsidies?
 Regulation?

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