MARKETS AND MARKET FAILURE IN HEALTH SERVICES Health Economic Course Series

Definitions Market = where demand and supply adjust through price.  can be seen as a tool or mechanism, for allocating resources in a society. Market failure = all the ways in which a specific market may not meet the conditions for social optimality. E.g. if there are barriers to entry, or a lack of information, then that market will fail to produce the best possible outcome. In bureaucracies  “government failure” = the ways in which a bureaucratic approach may fail to optimize social welfare.

Market mechanism Markets produce goods efficiently by balancing demand and supply through the price mechanism Market distribute goods according to the ability and willingness of consumers to pay for them – demand/supply.

Conditions for perfect market 1. Perfect information - Symmetric 2. ‘Rational’ behavior - Incorporating both individual and societal costs/benefits 3. Market exists - for all products desired by all people 4. Many buyers and sellers, homogenous products - so each is price taker 5. Equity or politics not considered

Market failures 1.Imperfect information 2.“Irrational” behavior 3.Externalities 4.Public goods 5.Incomplete competition  Reason for government intervention: Regulation, legislation, provision, … Also: social equity

Information asymmetric = One party to a transaction has better information that the other. e.g. car salesman, market for insurance or credit. Leads to less than ideal provision: -People avoid products -People pay less/more than what is might be worth Unless: -use of warranty, reputation -Performance related payments -Norms and standards

Information asymmetry - Health Uncertainty about products: Knowledge patient/doctor Difficult to distinguish products (heterogeneous) –Supplier-induced demand –Over/under-production –Low quality, high price Role government: –Accreditation –Quality Assurance –Health education

“Irrational” behaviour = People might not always do what is best for themselves ( still “rational” choice based on personal utility ) Leads to: - Over-consumption of “bad” goods (cigarettes) - Under consumption of “good” goods (education) Need to change incentives…

“Irrational” behavior - health Merit goods (good goods) = vaccines, vitamins, physical activity De-merit goods (bad goods) = cigarettes, drugs, speed Role government: –Health education –Subsidising / taxing consumption –Legislation

Externalities Side-effect of consumption or production of goods and services, that are not considered when consuming/producing. Positive externalities: –Individual benefit < social benefit –Individual cost > social cost  Under-production / consumption Negative externalities: –Individual benefit > social benefit –Individual cost < social cost  Over-production / consumption e.g. well-kept front garden, public artwork, volunteer, vaccine e.g. pollution, over-fishing, smoking

Externalities - Health Positive externalities E.g. prevention contagious disease, immunization, treatment STDs, caring  benefit of consumption/production is lower for individual for society as a whole  price paid will be below price it is worth  supply will be below what is ideal for society Role government: –Subsidize consumption/production –Provision  create market –Funding

Public Goods = non rival and non-exclusive good E.g. radio broad cast, fresh air… Impossible to set a price: –Non payers can not be excluded –Extra consumer doesn’t lead to extra costs No body willing to pay (free riding) Nobody willing to supply No additional costs of extra consumer No one can be excluded from consumption

Public goods - Health Healthy society: –Everyone benefits –Incentive to “free ride”: leave the healthy life-style and preventive measures to others. e.g. incentive not to be vaccinated if everyone else is? Who would invest in R7D for medicines in a completely liberalized private market? Role of government: -Subsidize consumption/production -Provision -Funding -Regulation (e.g. patient law)

Incomplete competition = One or few providers of goods (monopoly: single seller), or one or few buyers of a goods (monopsony: single buyer), who thus have power in the market to influence prices. e.g. OPEC: artificially high prices because of power of suppliers (as long as no alternatives)  artificial shortage of oil e.g. hirer of daily wage labour: few offering work (demand), ability to pay very low wages (low price)  artificial surplus of labour

Incomplete competition - Health Health care facilities often monopolies: –High start-up cost (investment in building and equipment, risks) –High barriers to enter market as supplier (specialized, long training, licensing) Limited choice for consumer: –Price set higher that costs, no incentive to be efficient or to provide quality services Role of government: –Provision –Quality control –Price regulation –Legislation

Equity Equity = being fair or just. Perfect market  technical (how) and allocative (what) efficiency, regardless of who gets  so inequality is not a market failure BUT Still reason for government intervention Trade-off between equity and efficiency? Social welfare as positive externalities?

Equity - Health Health = Human right Ethical duty of health workers to treat according to need, not ability to pay. In private market: Less supply at higher price than ideal for society Role government: –Guarantee human right for good health –Provision –Subsidizing –Funding

Recap… Perfect market Market failures Government intervention Legislation, regulation, subsidizing/taxation, funding, provision, social protection, … Government failures 1.Imperfect information 2.“irrational” behavior 3.Externalities 4.Public goods 5.Incomplete competition 6.Equity D=S, price adjusts, efficiency

Government interventions Enabling Changing environments in which private agents make decisions Public Provision Government provides health care services itself Examples: Subsidies, user fee, exemptions, quality standards, regulation Examples: NHS, vaccination programme, research

Government failures Asymmetric information –Government less specialized, and same information problems as market Incentives –If no profit motive, incentive to reduce costs? –Without price mechanism, incentive to produce/consume at optimal levels? Assumption of benevolent government –People excluded in economic, social and political “markets” –Incentive of electoral cycles – short term vision –“Regulatory capture” – vested interests, corruption

Market and government - health Elements of both market & government in health care: –Public funding of primary health combined with user fees for other, less essential services –Private health insurance combined with social insurance –Government subsidies/funding of education for health care workers but re-payment of student loans by employed workers –Health education and information to assist consumer choices –Public sector contracting to private sector.

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