Module Components

• Overview
• Assignments

Topics

• The Imperfect Health Care Market
• Market Failure, Government Regulation, and Public Policy
• Public Health Insurance - Medicare
• Public Health Insurance - Medicaid

NDNP 803 - Executive Leadership and Healthcare Economics

Module 6: Role of the Government in Health and Medical Care

The Imperfect Health Care Market

A perfect market is defined by several conditions called perfect competition:

• Perfect market information
• No participant with market power to set prices
• Non-intervention by governments
• No barriers to entry or exit
• Equal access to factors of production
• Profit maximization
• No externalities

Generally speaking, in economics, a perfect market is reached through the market forces of supply and demand, utility, and elasticity. However, in reviewing this list, health care is an imperfect market. From an economic perspective, some reasons why health care is an imperfect market:

Failure of Competition

The hospital industry is highly concentrated in many areas, though greater competition exist more broadly for physician services. Antitrust enforcement can play a role. Government also affects competition by trading it for incentives to innovate through the patent system (pharmaceuticals, devices).

As is the case for health insurance, competition can never be perfect in health care. The products, treatments, are not identical due to both provider and patient factors (your doctor does it differently than mine, I respond differently than you). Thus, health care services don’t really compete with one another as equal goods. Each is a unique product with its own degree of monopoly power. This is a source of market power that cannot be fully purged from a market-based health system, no matter what government does or does not do.

Public Goods

Some aspects of health are public goods, meaning it costs nothing for an additional individual to enjoy the benefit and it is not possible to exclude an individual from enjoying it. An example is herd immunity. As evidence that a free market might under-supply herd immunity, public school systems (governments) require documentation of childhood vaccinations (or evidence of a qualifying exemption). Public assistance (Medicaid, public clinics and hospitals) also increase access to care, facilitating the provision of the public goods aspects of health care, among others.

Externalities

Herd immunity is a positive externality of health care. So might be increased educational attainment and work force participation associated with good health. Both can reduce demands on public programs and buoy economic growth that benefits society in ways not captured by the participants in health care transactions. Therefore, the market might under-provide health care. (A related phenomenon is when a health insurer rationally does not “invest” in preventative care for its policyholders because it is not likely to capture the long-term benefits as policyholders switch to other insurers.) Government mandates and subsidies are among the possible responses.

Information Asymmetries

Physicians generally know more about how health services will affect patients than patients do. This can foster supplier-induced demand, contributing to an inefficiently high level of utilization. In general, private-sector solutions can be as or more effective than public ones. They included various means of contracting, monitoring, fraud detection, and care management.

Incomplete Markets

An incomplete market is one in which consumers would be willing to pay more than the cost of a good or service but it is not provided. Insurance markets are clearly incomplete. Today, there are millions of people who are denied participation in the market (due to medical underwriting) who might be willing to pay a fair premium. Given the low level of competition in insurance markets, it is very likely that products that would be profitable are not offered (because they’re less profitable than what is offered).

Until 2006, the market for prescription drug insurance for Medicare beneficiaries was glaringly incomplete. Until 1966, the market for hospital and physician services insurance for the elderly was also obviously incomplete. Government responses in all these cases (banning medical underwriting, encouraging exchanges, offering Medicare and Medicare Part D) are designed to address the incompleteness of health insurance markets.

Information Asymmetries

An information asymmetry exists when one participant in a market transaction knows more than another in ways that pertain to cost or price. Such asymmetries abound in health insurance. Individuals have private knowledge about expected utilization that insurers lack, leading to adverse selection. Individuals also may know more about their personal value of the insured services than do insurers, leading to moral hazard. Providers know more than insurers about cost and quality, leading to inefficient levels of reimbursement.

Private entities are likely just as capable of limiting moral hazard (e.g., by cost sharing or care management) and discovering cost and quality information (e.g., combating fraud) as government. Private entities can also address the degree of selection into their products, but not without exacerbating the problem of incomplete markets (e.g., not offering services that attract high risk enrollees or attempting to shed high risks).