Why Market Failure Exists in the Healthcare System?
Market failure is defined as the inefficient distribution of goods and services in a free market (The Investopedia). It can result from externalities, monopoly, information asymmetries, and factor immobility (Bator, 1958). Once market failure occurs, individuals may not be better off by taking rational actions, the total surplus will decrease, and deadweight loss might incur. One typical example of market failure is the public goods problem, in which people tend to consume more than they need. Economists argue that the reason for the public goods problem is people don’t need to pay for the goods. However, although healthcare is usually not considered as a public good, market failure occurs in the healthcare industry (Nutting, 2009). In this paper, I will explore why market failure pervasively exists in the healthcare system and come up with potential solutions.
The first reason is information asymmetries. Different from other industries, or market models, there is a huge knowledge gap between the consumers (patients) and suppliers (physicians) in the healthcare industry, which is consistent with the definition of asymmetrical information. Therefore, even if the patient doesn’t have severe disease, the doctors may persuade him or her to take more treatment or more expensive medical services. This phenomenon is named “Supplier Induced Demand” (SID), which means the physicians are more driven by personal interest when treating patients rather than the well-being of patients (Richardson, Peacock, 2006).
However, some economists argue that physicians are not driven by their pure interest in the SID model. Instead, they are motivated by their “perceived interest,” which includes fame, reputation, even the health of patients because the well-being of a patient might affect the evaluation of a physician in the healthcare system (Bickerdyke, I. et al., 2002). Yet, in either case, the demand curve might shift to the right side, while the supply curve might also shift to the right side to reach the equilibrium price of medical services (Bickerdyke, I. et al., 2002). Thus, the deadweight loss might occur, the optimal level of well-being for patients will decrease, and it is known as “market failure.”
Noticeably, the level of deadweight loss caused by SID depends on the price inelasticity of a service or good. If one service is price elastic for the patients, the demand curve will be comparatively horizontal. For example, few people would go to the hospital for a light cough, they may just buy medical pills and stay at home. Therefore, once the demand curve shift, the deadweight loss might be tremendous. However, suppose service is inelastic to patients, such as coronary angioplasty and fracture surgery. In that case, the deadweight loss will be comparatively small because even if the supplier does not persuade the patient to take more treatment, the patient will choose it voluntarily. Yet, both of them will be considered as market failures.
Lack of competition might also be a reason for market failure in the healthcare system. Unlike other free markets, the healthcare system usually has high barriers to entry, which will lead to few competitors in the healthcare market (Wheel Team). On the one hand, a medical student needs a comparatively long period to get into the healthcare industry, which increases the threshold for becoming a doctor. Plus, the hospitals need to pay physicians and other numerous workers to ensure steady maintenance. On the other hand, a professional hospital’s supply chain and transportation are complex, and the cost is usually very high. Combining these factors, hospitals or healthcare services are deemed to be scarce in our society (Wheel Team). What’s more, large hospitals may coalesce and buy out their competitors (Pipes, 2020). As a result, a monopolist or several oligarchs might occur in the healthcare industry.
Some people may argue that government will prevent the monopoly of healthcare resources because it is tightly associated with citizens’ well-being. For example, there are non-profit hospitals and public hospitals in society. However, non-profit or public hospitals are running by changing the mixed strategy of services (Horowitz et al.). For example, they are more likely to provide non-profitable services and get reimbursed by the government. In contrast, they may not offer as many profitable services as for-profit hospitals. Therefore, patients still have limited choices. In this situation, the market price is higher than in a competitive market, the demand curve will shift inward, and deadweight loss will incur. In other words, lack of competition is a reason for market failure in the healthcare system.
So, is there any method to prevent or reduce market failure in the healthcare system? The answer is positive. First, it would be beneficial to reduce Supplier Induced Demand. On the one hand, patients should have the right to be informed when receiving treatments. In fact, with the development of the Internet, obtaining knowledge is easier and easier for patients (Bickerdyke, I. et al., 2002). Plus, the physicians should respect patients’ rights of being informed. If a patient has more knowledge about treatment, they may choose their optimal solutions, which is not necessarily the same as the best choice of physicians. Plus, patients should reserve the right to make decisions if they have the capacity to do it. As research shows, the physicians in Iran are both supervisors and decision-makers. Therefore, they are more likely to choose the treatment based on their interest (Keyvanara et al., 2014).
On the other hand, hospitals should not exert that much burden on physicians. If the physician is punished because of a non-perfect surgery, fewer and fewer physicians will be willing to perform high-risk surgeries. Even if they take the risk, they may over-use every treatment to ensure patients’ health. Although it sounds ideal, it may not be the optimal choice for both physicians and patients because it will take a lot of money and time, which may further reduce their utility. Additionally, the government should encourage more hospitals to get into the market. For example, the repealing certificate-of-need laws in Tennessee had prompted the development of 63 hospitals, and this action reduced the cost by about $223 per capita (Pipes, 2020). By taking the actions above, the problem of Supplied Induced Demand and lacking competition would be alleviated.
To conclude, information asymmetries and lack of competition are major reasons that resulted in the market failure of the healthcare industry. Due to asymmetrical information, Supplier Induced Demand might occur. It means physicians may suggest patients take more treatments than they need, which induces deadweight loss. Or maybe the physicians over-treat the patients for their health, yet it would reduce the utility of physicians and patients as well. Also, large hospitals are likely to be monopolies and affect the demand of patients because there are not enough competitors. To alleviate the market failure, physicians should respect patients’ right to be informed, and doctors should not be both supervisors and decision-makers. Plus, the government may implement policies to encourage more hospitals or healthcare companies to get into the healthcare industry. Thus, the market failure of the healthcare industry would be corrected, and the well-being of citizens will be boosted.
Reference:
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Pipes, Sally. “American Health Care Needs More Competition, Not Less, to Bring down Prices.” Pacific Research Institute, 3 Feb. 2020, https://www.pacificresearch.org/american-health-care-needs-more-competition-not-less-to-bring-down-prices/#:~:text=There's%20ample%20evidence%20that%20a,to%20wallop%20insurers%20and%20consumers. ~
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