THE FIRST BIG POINT
Market Imperfections Stem from
Problems with One of Three Things:
Competition, Information, Incentives
COMPETITION
• Utility Regulation. The structure of costs
makes it practical to have just one producer.
• Antitrust Law. Prevents non-competitive
behavior, or tries to. Applies to Health Care
Markets as well as other markets.
• Lack of Competition typically causes
production to fall short of efficiency, as
prices get set “too high”
INCENTIVES
Incentive Problems devolve to property rights:
• EPA, because people don’t have an enforceable,
defined “property right” to clean water and air.
• Subsidies for medical care, because people don’t
own “property right” to benefits conferred to
others when they are treated.
• Incentive Problems can lead to production in
excess of efficiency (costs > benefits for some
units) or production short of efficiency (benefits
would exceed costs for some extra units).
INFORMATION
• FTC enforces truth-in-advertising
• FDA approves new pharmaceutical drugs
• State Licensing Boards license physicians, nurses,
and a wide range of other professions
• Lack of quality information leads to underproduction, relative to efficiency, since it reduces
consumers’ willingness to purchase care and gives
providers some ability to raise prices. Other kinds
of poor information can lead to overproduction
(such as in moral hazard).
THE SECOND BIG POINT
When Comparing the Effectiveness
of Government and the Private
Market in Addressing Market
Imperfections, Ask Who Does Better
in Terms of Competition, Incentives,
and Information?
COMPETITION
• More competition is better, but sometimes it is
hard to tell whether an action is pro-competitive or
anti-competitive. The government / courts, who
enforce antitrust laws, might make a mistake.
• For example, self-referral (physicians referring
patients to facilities they own part of for
treatment) appears anti-competitive, but could be a
way of ensuring quality.
• Mergers can be pro-competitive or anticompetitive, as we will discuss later.
INCENTIVES
• Profit-making firms have incentives to lower costs
and provide quality to the degree that it is
rewarded by the market. In the process, the
competition (if it exists) is good for consumers
and promotes efficiency.
• Government agents have incentives too. What are
they? What will encourage government
employees to make decisions that encourage
efficiency?
• Not-for-profit firms have different incentives than
for-profit firms. What are they?
INFORMATION
• Since information is a “public good,” free market
may not produce enough. On the other hand, does
that mean we should subsidize textbook
publishers?
• There is a difference between the information
available to government agents and to private
agents in the market. The government may have
superior resources to gather the appropriate
information, but there is a lot of decentralized
information about choices, opportunities, risks,
and preferences, that can be hard to measure or
infer (just ask any economist).
SPECIFIC EXAMPLES
OPTOMETRY and
ADVERTISING
• Limitations on advertising most likely reduce
competition. In particular, it makes it more
difficult for entrants to establish themselves in a
market.
• Two studies (I gave you a handout from the
Feldstein book) found 1) advertising lowers
prices, 2) overall quality did not differ between
markets with more/less advertising, 3) greater
consumer satisfaction with optometrists who
advertise.
MANPOWER PLANNING
• Advocates of manpower planning do not claim a
market imperfection involving information,
competition, or incentives! So…why will the
market give the “wrong number” of health care
professionals?
• What incentive does the planner have to assess the
need/availability of HC professionals accurately?
Could he be biased because of incentives? What
incentive do employers/HC professionals have in
their hiring/job acceptance choices?
• Compare the information available to the market
and to the planner: who has better information?
OSHA, SMOKING
• As homework problems.
• In all these cases, too, it is not clear who has
the better information or the more
appropriate incentives, or whether actions
being taken are pro-competitive or anticompetitive.
THE THIRD BIG POINT
There Are Many Ways to Try to
Correct Market Imperfections. Your
Objective: Maximize the
Competition, Information, and
Incentives.
POLLUTION CONTROL:
FOUR OPTIONS
This, um, “factory” puts out pollution that
harms the children in this school. (Though
not as much as the food in the cafeteria.)
OPTION 1: DIRECT CONTROL
• Tell the polluter what to do. For example,
one might require the factory to install a
scrubber.
• This does not take advantage of the
factory’s private information about how to
limit pollution, nor their incentive to limit
the pollution in the most cost effective way.
OPTION 2: A POLLUTION
TAX
• Making them pay for pollution costs is sort of like
assigning the property right for clean air to the
people. Now the factory can decide how much
pollution to produce and what is the most costeffective way to reduce it.
• One limitation of this approach is that it does not
harness the benefits of competition in lowering
pollution. Perhaps another nearby factory could
reduce the same amount of pollution at lower cost.
OPTION 3: TRADABLE
EMISSIONS CREDITS
• Allowing the factory to pay a nearby factory to
reduce its pollution instead utilizes competition to
ensure the pollution is reduced at lowest cost. It is
harder to cut costs in older factories, so more of
the pollution control is moved to newer factories
or old ones are mothballed entirely.
• Neither this approach, which (often) specifies an
amount of pollution to be reduced, nor the tax
allows citizens’ preferences about avoiding
pollution to be included in the solution.
Government decides the tax / pollution reduction.
OPTION 4: NEGOTIATION
• Actually giving the school the property right to
clean air allows the school board to negotiate the
pollution tax / pollution reduction with the factory.
Thus community preferences on pollution
reduction are now incorporated into the solution—
information that was not used before.
• In practice this isn’t used because it’s not practical.
However, the tradable emissions credits are used
quite a bit with a fair degree of success.
THE FOURTH BIG POINT
I’ve tricked you a little ….
GOVERNMENT OR
ADMINISTRATION?
Anytime a decision is made administratively—
you want to be in management?—the
information and incentive issues discussed
come into play. Do you have the best
information? Do your employees, who
might have the best information, have an
incentive to use it for the good of the
organization / patient? Is there anything
you can do to improve that situation?