Feedback
1 Allocative efficiency describes a situation where resources are allocated and commod- ities distributed in a way that maximizes social welfare. Social welfare is total benefit minus total cost. For a particular market, social welfare is represented by the area below the marginal social benefit curve and above the marginal social cost curve. Social welfare is maximized at the point where marginal social benefit (MSB) equals marginal social cost (MSC). If MSB is greater than MSC then you can increase social welfare by increasing quantity because the extra benefit is greater than the extra cost. And vice versa: if MSB is less than MSC then you can increase social welfare by decreasing quantity because the benefit lost is less than the cost saved. A free market will be allocatively efficient if demand is equal to MSB and supply is equal to MSC. This will only be the case if there are no market failures.
2 It is a good thing for a market to be allocatively efficient because it means that total benefit to society is maximized. This means that the sum of the utilities of every person is maximized. However, this might mean that some people have a very large amount of utility but others have a relatively small amount. An allocatively efficient allocation might be considered to be unfair. In this case there is scope for government intervention even though there is efficiency. Equity is another objective of economics and is discussed in Chapter 12.
treatment is for an infectious disease then there will be benefits to the wider com- munity from the reduced infection.
The last condition, that people make a choice over their own treatment, also does not hold in all areas of health care. Some patients will be incapable of making a decision. Also, people might become anxious as a result of having to make a decision about their health.
All of these examples would suggest that patient sovereignty is, to some extent, quite limited.
There clearly are failings in the market for health care but there are problems involved with government intervention as well. Government intervention will inevitably require some public funding (probably from taxation). If the govern- ment goes as far as taking over the health care market then huge amounts of finance will be required. Taxes are distortionary, whether they are on goods and services or on incomes. They change the equilibrium price and quantity and reduce social welfare in these markets. It is the extent of the market failure that is the important consideration. If market failures associated with health care are rela- tively minor then health care should probably be left to the market. In the next chapter you will assess the severity of market failures in health care. Then, in Chapter 12, you will look again at the arguments for and against government intervention.
Now, in the final activity of this chapter you will see an alternative view of the health care market. In the following extract, Martin Green (1995) presents the case made by supporters of a free market for health care. (Note: he is not related to David Green, whose views he describes.)
Activity 10.3
When you have finished reading, answer the following question:
What might a government do to try to make the health care market more competitive?
The case for a free market in health care
What would happen if all health care was bought and sold in the market? The answer to this question is fiercely debated. Free market economists such as David Green argue that the market would deliver the best possible care at the lowest possible cost. He supports his view by using evidence from the USA. In 1986, he looked at the performance of the health care market in the USA and came to the conclusion that the introduction of a more effective free market in the early 1980s resulted in the emergence of a flexible, cost- effective system. He claimed that problems often associated with the American health care system were the result of a failure of the free market to operate.
Green argues that the problems of US health care in the 1960s and 1970s were the result of the doctors’ monopoly power over supply. The doctors achieved this partly by restrict- ing entry to the medical profession through limits on medical schools and partly by keeping consumers in ignorance. The doctors association, the American Medical Association (AMA), ‘was able to keep a tight grip on the number of doctors trained and hence to limit
the supply of doctors in active practice’. They also maintained the monopoly by preventing doctors from advertising which prevented consumers from gaining the information they needed to make a rational market choice.
This monopoly power was fatally undermined in 1982 when the US Supreme Court outlawed the AMA’s ban on advertising. The Federal Trade Commission had already enforced a number of other pro-competition policies on the doctors such as making price fixing by the Michigan State Medical Society illegal. Combined with a significant expansion in the number of doctors, this led to the effective emergence of competition. Green argues that the emergence of this effective competition in the health care market has led to exactly the results predicted by the free market model. What are these results? A perfec- tively competitive free market will provide an allocation which is allocatively efficient. This means health care which accurately reflects consumer demand. It will also be productively efficient and deliver the health care for the lowest possible cost.
Green believes that American consumers now have a much greater choice of where to get their medical treatment and that increased competition has led to the producers of health care becoming more responsive to consumer demand. Another result of the increase in competition, Green argues, has been a significant fall in costs. In other words he claims that American health care has become more productively efficient. He cites as evidence the fall in hospital use and the fall in visits to doctors’ surgeries between 1981 and 1985 – ‘the producers are on the defensive as competition cuts costs and promotes high quality’. In particular, he notes that some day surgery centres are able to carry out over 750 medical procedures at savings of between 30% and 50% of hospital in-patient charges. He also cites the AMA’s contention that as a direct result of increasing competition, the real purchasing power of doctors’ incomes fell in 1984.
Green believes that the extension of the free market in health care in the US in the early 1980s brought substantial benefits, and in particular delivered exactly the kind of result that the free market model predicts. He does not claim that the American health care system is without problems but he does believe that those problems stem from the effects of state interference rather than the failure of the market.
Feedback
The government should carry out policies that make restrictive practices illegal and which increase the knowledge of patients. Policies carried out in the USA to reduce monopoly power in the health care market have included:
• outlawing the ban on advertising (which had suppressed consumer information)
• banning price setting by professional bodies – price setting implies that doctors are not competing in terms of price
• increasing the number of medical graduates
Markets are not the only way that efficiency can be fostered. In public (and sometimes private) provision of health care, individual programmes are financed by setting budgets (rather than charging a fee for every service). In these cases economic evaluations can be carried out so that resources are allocated efficiently. Services are provided if they yield a large health benefit compared to their resource use. Services for which this is not the case are not provided.
In this chapter you have looked at whether health care markets are efficient, and a number of market failures were identified. In the next chapter you will look at these market failures in more detail and consider some remedial policies.
Summary
You have learned about the circumstances necessary for a perfectly competitive market in which patients would be sovereign and firms are price takers. You also saw how allocative efficiency is when social welfare is maximized – that is, marginal social benefit is equal to marginal social cost. Perfectly competitive markets are allocatively efficient because marginal social benefit equals demand and marginal social cost equals supply. However, most areas of health care are not highly competitive, which you will learn more about in the next chapter.
References
Parkin M, Powell M and Mathews K (2003) Economics (5th edn). Harlow: Addison-Wesley.
Donaldson C and Gerard K (2005) Economics of health care financing. The visible hand (2nd edn). Basingstoke: Palgrave Macmillan.
Green M (1995) The economics of health care. London: Office of Health Economics.