Module Components

• Overview

Topics

• Divergences from a Competitive Market
• The Role of Government When Externalities Occur
• The Importance of Health Policy

NDNP 803 - Executive Leadership and Healthcare Economics

Module 7: The Production of Externalities in Health Care

The Role of Government When Externalities Occur

A market economy is an economy in which decisions regarding investments, production, and distribution are based on supply and demand, and prices of goods and services are determined in a free price system. The major defining characteristic of a market economy is that decisions on investment and the allocation of producer goods are mainly made through markets, without government intervention. This is contrasted with a planned economy, where investment and production decisions are embodied in a plan of production.

Market economies can range from hypothetical laissez-faire and free market variants to regulated markets and interventionist variants. In reality market economies do not exist in pure form, since societies and governments regulate them to varying degrees. Most existing market economies include a degree of economic planning or state-directed activity, and are thus classified as mixed economies. Thus, the term, free-market economy, is sometimes used synonymously with market economy, but it may also refer to laissez-faire or free-market anarchism.
 
Market economies do not logically presuppose the existence of private property in the means of production; a market economy can consist of various types of cooperatives, collectives or autonomous state agencies that acquire and exchange capital goods with each other in a free price system. There are many variations of market socialism hat involve employee-owned enterprises based on self-management that operate in markets, as well as models that involve public ownership of the means of production where capital goods are distributed through markets, such as the social market economy of China.

The term market economy used by itself can be somewhat misleading. For example, the United States constitutes a mixed economy (substantial market regulation, agricultural subsidies, extensive government-funded research and development, Medicare/Medicaid), yet at the same time it is rooted in a market economy. Different perspectives exist as to how strong a role the government should have in both guiding the market economy and addressing the inequalities the market produces.

Role of Government:

• Government can ban an undesirable activity; however, this is often not socially optimal as some level of externality may be necessary to produce/consume the good (such as in the case of transportation). Society has to balance the costs and benefits of the externality.
• Laws can be passed banning all production or consumption involving negative externalities and requiring production and consumption involving positive externalities.
• The first method of government intervention is command and control, also known as regulation. The government can remedy an externality by making certain behaviors either required or forbidden. Laws can be passed banning all production or consumption involving negative externalities and requiring production and consumption involving positive externalities. For example, the government could ban pollution and cigarette smoking and require everyone to attend school and get vaccinated.
• Although it sounds simple, it is not. For example, it is impossible to prohibit all polluting activity. Therefore, society should weigh the costs and benefits to decide the kinds and quantities of pollution instead of eradicating entire pollution.
• This method may not be optimal because some production/consumption of the good may be necessary. For example, if all pollution were banned, we would no longer be able to drive cars or use electricity. While there are non-polluting methods of transportation and electricity production, these methods may not be efficient due to their high cost.
• Another problem with this method is that policymakers are forced to make cost-benefit calculations where these types of calculations are impossible. It is nearly impossible to calculate the cost to or the benefit derived by society from allowing pollution, so it is nearly impossible to know if the right decision is made.