Externalities is present whenever some economic agent’s welfare (utility or profit) is ‘directly’ affected by the action of another agent in the economy (176,H,D). In certain health care, people can benefit from others’ consumption, which will result that the social marginal benefit of health care is higher than the individual. Subsequently, the problem of underproduction will arise.

Adverse selection and moral hazard in the health insurance market

Health care is significantly different from common commodities such as food and clothes, since we don’t know when we need and how much we need pay. With response to the uncertainties, the market tends to develop insurance, which makes people better off via reducing the uncertainties.

Problems specifically adverse selection and moral hazard inevitably exit in the market. Adverse selection is caused by the asymmetric information between the insurance company and the consumers, inducing high insurance fees. Nonetheless, people in low risk will be driven out of the market.

Another problem is the moral hazard. When people have insurance, they tend to be less careful about their health status increasing their demands of health care service.

The patients with insurance will demand more health care resources than they actually need, which will cause a welfare loss.

Assume that marginal cost is constant. The amount of health care that should be provided is Q1, where marginal cost equal to marginal benefit. However, because of the excess demand of patients, Q2 will be provided. And the shaded area represents welfare loss.

The information asymmetry between patient and doctor: agent problem

In health care market, the relationship between the doctor and patient is much different from the normal buyers and sellers. The patient is there to give the doctor all the information t doctor needs in order that the doctor can make a decision, and the patient should then implement that decision once the doctor has made it (CD, 45 Williams). As a result, patients’ consumption largely depends on the doctor. Therefore doctors have an incentive to make patient consume more in order to make more profit. Hence overproduction occurs.

Monopoly

With respect to two reasons, the certain hospitals in some areas can easily achieve local monopoly. Firstly, People in one community may have only one choice of the hospital or doctor for others far away from their living areas. Secondly it is the natural monopoly. Because of the contradictory between the high fixed cost and the confined demands, only one hospital can make profit.

Part 2: Perception from the U.K. market

For the health care, the resource cannot be allocated efficiently in the free market. Government interventions play an essential role in providing the health care. In order to cope with such flaws, the UK government established NHS providing the civil with the health care.

Monopoly power of hospital: Before making the purchasing decisions, buyers always want to compare between goods and service provider with different calibrations. Since free market will induce the complicated management, which had little relationship with the opportunity cost, government will pull the free-market price, with the mandatory power, to the more preferable price where price equals average cost, at which point, the pricing behaviour finally strikes to more consumer surplus.

If the health service market is in the state of monopoly, where there is only one provider in the whole facet, in order to realize maximization of the profit, the monopolist will choose the point M() to produce the product in the market, in which consumer surplus is . However, since the NHS is such product that has the properties of public goods, the government itself would ensure that the NHS covers all the groups in need. In consequence, government intervention would drag the production point from M() to C(), where the consumer surplus becomes larger than the previous one, by doing so more public groups will enjoy the benefits of the National Health Service.

Externality:

As mentioned above, in the free market, the health care will be underprovided because of the externality. However, in UK, if the authorisers know the exact amount of health care maximizing the social benefit, they would constrain adequate health care within budget of NHS to provide. Budget constrain determines the quantity of resources available for the NHS and thus explicitly setting the maximum amount of health care available to NHS patients as a whole. As showed in the graph, we assume the marginal cost is constant. L2 represents the individual marginal benefit, L1 the marginal benefit of the others people, and L3 the social marginal benefit, namely the sum of L1 and L2. People will consume at point A. However, the social optimal point is B where social marginal benefit equals to marginal cost. As a result, only if the authorisers have the enough information at point B, they would provide proportional budgets for the health care NHS could offer.

Excess demand due to moral hazard:

In insurance-based health care systems, the problem of potential ‘excess’ demand exists because of what has become known as ‘moral hazard’, which has consumer side and supply side.¬ From the consumer aspect, moral hazard in health service comes on the unbalance between the benefit and cost for treatment.

In Britain, NHS is free so that there would be almost zero financial cost but benefit, at the same time, still there. In other words, some would require further and better treatments to make them more healthy though they were not really in bad condition.

Although the existing of moral hazard cannot be suspended immediately, the NHS still does try to reduce it. The famous one is a system solution: doctors decide who needs treatment. As mentioned, NHS is a system classified and the ground floor is GP. Particularly, GPs act as both a guide( to the appropriate specialist) and as a filter. In other words, patient would not be able to have further treatment without the permission of his GP. The exist of GP reducing the risk of moral hazard for information asymmetry. This helps overcome the problems of consumer ignorance and provides a means of controlling the level of demand.­

Agent problem:

In NHS system, all the GPs and doctors are employed by the government. The aims of the hospital are not to make a profit. Doctors will either be under the contract to the NHS or be salaried, they have no financial incentive to induce patients to consume more health care. Additionally, the separation between the doctors’ payment and endowment would increasingly overcome the agency problems.

Problems of the NHS:

Firstly, low efficiency:

If the government intervenes much more than it should in the situation, undoubtedly, the authorities are running the risk of dragging effective motivations down. Because of the mechanism that the doctors will either be under the contract to the NHS, doctors in such government-owned institutions needn’t worry to make a profit. In consequence, hospitals tend to have long waiting queues. Inadequate to cope with the booming amount of the patients long for free and partially non-urgent treatment, market will remain in low efficiency. The richer group in society will choose the “private” wards. On the other hand, those who had no enough money had to wait in a long queue for their wards at NHS. Indispensably, low efficiency would influence the quality of the system rendered towards the NHS.

Underproduction or overproduction of health care:

Because that the central planner controls the supply health care through the budget of the NHS, the health care has a risk of underproduction or overproduction. If the central planners were well-informed with the consumers’ demand, they will provide as much health care as what can maximize the social optimal. In effect between central planner and patients the asymmetric information makes it unlikely to provide the health care at the exact amount.

Part 3: U.S. Health Care

The health insurance in US can be divided into two parts, one of which are private insurance consisted of employment-base and direct-purchase insurance, the other by government.

The government programs include 9 departments () which generally cover the elderly disabled, children, veterans and some of the poor.

From the information above, it’s obvious that US government doesn’t take over the healthcare market. The government allows the market to allocate resources under a certain system. Therefore, how does this system work to avoid market failure?

Agency problem and monopoly power of the hospital: As we have mentioned above, the agency problem and monopoly power of the hospital will make the market failure. However, in America, the serve supervision mechanism solves these two problems effectively. Current Procedural Terminology (CPT®) is most widely accepted medical nomenclature used to report medical procedures and services under public and private health insurance programs (http://www.ama-assn.org/ama/pub/physician-resources/solutions-managing-your-practice/coding-billing-insurance/cpt/about-cpt.shtml). The doctor use the CPT to record what medical services or care they have provided with the patient and send them to the insurance company. To maximize its own profit, insurance company will spare no efforts to drive down the cost. Consequently, doctor has to give evidence to show that the drugs or services he or she provided are essential. Under such supervision and manipulation, the efficiency will be improved and the agency problem will be solved. And because of the existing of CPT, the prices of the health services are uniform all around the country. The hospital can not use its monopoly power to raise the price of health services. What they can do to make more profit is just to provide more service.

Adverse selection: In US, the government administrate social insurance which is called Medicare, providing insurance for people 65 or older, or people of any age with certain disabilities or meet some certain criteria(http://www.medicare.gov/navigation/medicare-basics/medicare-benefits/medicare-benefits-overview.aspx)

With this policy, most of the high risk people will be taken out the health insurance market by the government which reduce the adverse selection problem to some extent. And the insurance companies are classifying consumers into different insurance contracts according to how risky are they getting specific disease. Insurers in America decide the contract price depending on some indexes such as age, the health condition at present, the previous condition, habits .etc. Different people in different health condition could find specific and suitable contract(公司网站)

Excess demand of health care due to the moral hazard of the health insurance: The moral hazard problem of the consumers can be dealt with the managed care which are programs intended to reduce unnecessary health care costs through a variety of mechanisms (^ “managed+care” Managed Care. National Library of Medicine). When you have bought insurance, you can choose an primary care physician who are in contract with the insurance company. When you are ill, you should go to the primary care physician first. If they can not handle your illness, they will introduce you to specialists who are also have contract with the insurance company. The primary care physician and specialist who are in contract with the insurance company will consider the benefit of insurance companies which will deter the excess demand of health care.

Equity problem: To guarantee the equity of society, the government programs have a very significant role to play. It’s acknowledged that in reality a majority group in society involved in the government plan cannot afford the medical fees or the private insurance. Through the program such as Medicare, Medicaid etc, government provides insurance for people who may not able to cover the insurance fees. And in the private insurance industry, according to the Sec.211 in Affordable Health Care For America Act­, the insurance company cannot reject the consumer who has already been in bad condition which provide the chance for everyone to get an insurance.

On the contrary, this health care system will cause some new problems in the market.

According to the US Census Bureau, in 2009 US together spent $2.5 trillion, $8,047 per person, on health care. This amount represented 17.3% of the GDP, up from 16.2% in 2008. What’s more, the cost of US health care is ranked the highest in the world.

From the evidence above, we can safely draw the conclusion that U.S. as a whole pays the most in the world for medical care. Among all these payments, drugs expenditure plays an influential role, which deduced the problem of high drug prices in the U.S. medical market. Accordingly, the reasons behind this particular market behavior can be argued as follows:

It is inevitably obvious that two controversial forces coexist in the U.S. health market: one is the certain private medicine dealers in the market as powerful as enough to, in around sense, serve as the monopoly who will be less willing to produce the extra unit of goods and services in order to maintain in a relatively high level of prices and to pursue high volume of profits(figure 1); while on other side, it is the government whose power is less influential to intervene the pricing mechanism that cannot drag the medicine prices to social optimal point. Unquestionably, these highly fragmented purchasers in the U.S. health care market could not constitute monopsony(figure2) in the market as powerful as much to influence the pricing mechanism.

figure 1

From this figure, without the drug patent, point A will be the equilibrium point under the competitive market because on this point MC=MA. However, if the medical company owns the drug patents, then he will become a monopoly for a long time. To maximize the profit, the producer will choose the quantity where MR=MC (point B). In the chart, the profit will be the rectangle BCP*.

figure 2

The figure shows that, in the perfect competitive market, A point will be the equilibrium point where supply equals demand. However, if there is only one buyer (monopsony) in the market, he will choose the point (point B)where MC=MR to maximize the profit. Then the price of the goods will be drag down from P *to P1.

On the other hand, this sort of free market competition also guarantees that the providers in the market would more like to use further advanced technology to hold the novel professional patents as monopoly so that they can constrain low cost to derive high profits, which in turn, undoubtedly, drives the system working more efficiently and more productively. With the incentive of profits, U.S. is one of the world leading countries in the realm of technological medical improvement.