Healthcare is an industry where economic principles often clash with reality. While the ideal market relies on efficiency and balance — where supply and demand are in equilibrium — healthcare defies these norms.
Market failures occur when resources are not allocated efficiently. Four primary sources of market failure in healthcare are market power, asymmetric information, externalities, and public goods. Understanding these failures is essential for designing policies that ensure equitable access and improve overall system performance.
1. Market Power: The Inefficiency of Control
Market power arises when a single buyer, seller, or small group can influence prices, disrupting the equilibrium between supply and demand. In healthcare, this often manifests as monopolies or monopsonies.
Monopolies occur when a single provider dominates a market. For example, in rural areas with only one hospital, the provider can set prices well above competitive levels, limiting access to affordable care. Similarly, pharmaceutical companies with exclusive patents or exclusive distribution rights can charge exorbitant prices. One of the most egregious examples was Martin Shkreli and his company Turing Pharmaceuticals who raised the price of Daraprim, an antiparasitic drug used to treat HIV, by more than 5,000% in 2015. These practices create inefficiencies, leading to reduced affordability and access to potentially lifesaving medication.
Monopsonies, on the other hand, occur when a single buyer holds excessive market power. Hospitals, for instance, may employ most of the nurses in a region, enabling them to suppress wages. While this benefits the hospital’s bottom line, it may lead to nursing shortages as professionals seek better-paying opportunities elsewhere. Nurses can unionize to push back against monopsony power, but this comes with its own limitations, such as the creation of inflexible workplace rules, difficulty in firing inefficient workers, periodic strikes, and the potential for increased conflict between managers and workers.
Not all monopolies are inherently harmful. Natural monopolies — where a single producer operates more efficiently than multiple competitors — can lower costs and improve access. Water purification plants are an example, often regulated or operated by governments to protect consumers while maintaining adequate supply.
2. Asymmetric Information: A Knowledge Imbalance
In healthcare, asymmetric information — where one party has significantly more knowledge than the other — creates inefficiencies and distrust. Patients rely heavily on healthcare providers to guide their decisions but often lack critical information about costs, quality, or even the necessity of care.
Patients rarely know the true cost of medical procedures in advance, leading to surprise bills and financial strain. Even healthcare providers may struggle to navigate the complexity of insurance reimbursements, leaving patients confused and vulnerable.
Information about quality in healthcare also remains opaque. While online reviews and star ratings for hospitals or nursing homes help to some extent, they fall short of offering the transparency seen in other markets, such as consumer goods or travel.
Lack of information skews decision-making, with patients often agreeing to costly treatments without understanding alternatives. Efforts to improve price transparency, such as hospital requirements to publish procedure costs, aim to reduce this imbalance but remain incomplete. Patients still struggle to understand how these prices align with their insurance coverage or out-of-pocket limits.
3. Externalities: Unintended Costs and Benefits
Externalities occur when the production or consumption of a good imposes costs or benefits on third parties that are not reflected in market transactions.
Healthcare has numerous examples of positive externalities. For instance, vaccinations benefit not just the individual receiving the shot but the entire community by creating herd immunity. This reduces the spread of infectious diseases and protects those unable to get vaccinated. However, since the benefits extend beyond the individual, private markets often underfund vaccination programs, necessitating government subsidies and mandates.
Healthcare also has many instances of negative externalities. Tobacco consumption is a classic example. Smokers not only harm their own health but also impose costs on others through second-hand smoke and increased public healthcare expenses. Policies such as taxation and smoking bans aim to reduce these externalities, aligning individual choices with broader societal interests.
4. Public Goods: The Challenge of Non-Excludability
Public goods in healthcare, such as disease surveillance and public health infrastructure, are non-excludable (available to all) and non-rivalrous (one person’s use doesn’t diminish availability for others). These characteristics make them invaluable to society but often unprofitable for private firms to produce.
For example, a government-funded hospitals in rural areas may serve as a public good, ensuring access to care in underserved areas. Without government support, such facilities would struggle to remain operational due to high initial setup costs and reduced prices charged to patients. Similarly, clean water and sewage systems are essential public goods that protect community health but require government investment to ensure universal access.
A key challenge faced by public goods is the free-rider problem, where individuals benefit from public goods without paying for them. For instance, free clinics serve low-income patients but may also serve individuals who can afford care elsewhere, leading to increasing wait times and reduced access for low-income patients. Eligibility criteria and user fees are common strategies to address this issue.
Addressing Market Failures
Government intervention is crucial in mitigating market failures and ensuring equitable healthcare access. Strategies include:
- Antitrust Enforcement: Preventing monopolistic practices and promoting competition, such as by limiting hospital mergers that could significantly reduce consumer choice.
- Price Transparency: Requiring hospitals to disclose procedure costs so that patients can make informed decisions.
- Regulating Externalities: Regulating the private behavior of individuals or firms so that it is aligned with societal well-being, such as tobacco taxes or emissions controls.
- Subsidizing Public Goods: Ensuring widespread access to essential services, such as funding vaccination programs, community health centers, and public health initiatives.
The bottom line
Healthcare is not just an economic good; it is a shared societal responsibility that requires collaboration between markets, governments, and communities. As such, healthcare markets walk a delicate balance between economic efficiency and social obligation. While market mechanisms can drive innovation and improve resource allocation, they often fail to provide equal access to services or account for the clear societal benefits that flow from a healthy population.
Recognizing and addressing the root causes of market failures — whether through antitrust actions, subsidies, or public health investments — has the potential to create a pathway toward a more equitable and sustainable healthcare system.
Casey Ma is an MBA and MPH student at Yale University, specializing in Healthcare Management. With a background in strategy consulting, marketing, and project management, her passion lies at the intersection of healthcare transformation and strategic problem-solving. She is an advocate for collaborative innovation and enjoys engaging with professionals who share her enthusiasm for the healthcare and marketing sectors.
Image: DALL-E
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