Supply and Demand: Government Interference with the Unhampered Market in U.S. Health Care
Gilbert Berdine MDa
Correspondence to Gilbert Berdine MD.
Email: Gilbert.Berdine@ttuhsc.edu
SWRCCC 2014;2(7):21-24
doi:10.12746/swrccc2014.0207.085
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Many of the terms and concepts used by economists are poorly understood by the general public. This article will try to explain basic terms and concepts of economics and illustrate how they apply to U.S. Health Care. None of the material presented is controversial or dependent on the school of economic thought to which one belongs.
Figure 1 is a basic illustration of supply and demand
in what is called the unhampered or free market.
The free market is quite simple: a free market
exists wherever and whenever two or more people
get together to voluntarily exchange goods. There are
no regulations as to what can be sold, what can be
purchased or what prices can be charged. The only
restriction is that all exchanges are voluntary rather
than coerced by force.
Contrary to popular thinking, neither supply nor
demand is a single number. Rather, both supply and
demand are a family of numbers representing the
price at which a quantity of goods will be either sold
(supply) or purchased (demand). The shapes of the
two curves depend on many things, but there are a
few generalizations that can be made. The slope of
the supply curve must everywhere be greater than or
equal to zero. One cannot possibly induce (in a free
market) a greater supply by offering a lower price.
The slope of the demand curve must everywhere be
less than or equal to zero. One cannot possibly get
more people to purchase a given good by asking for
a greater price.
Given the constraints on slope, the supply and
demand curve must always intersect at a point. That
point is called the market clearing price. This is the
price at which all people in the market will be left satisfied.
This is not to say that everyone will make a
purchase or sale. All the people who sell will value
the market clearing price greater than the good sold.
All the people who buy will value the good purchased
greater than the market clearing price. All the people
who do not sell the good value the good greater than
the market clearing price – just like those who purchased
the good. All the people who do not buy the
good value the market clearing price more than the
good – just like those who sold the good. At the end
of the day, everyone is left with what they value more
– either the good or the market clearing price amount
of money. There are no unsatisfied sellers or buyers.
The only way to change the number of exchanges
would be for either the buyers or sellers to change
their priorities.
One type of government interference with the
unhampered or free market is regulation. A regulation
decreases the number of people who can or will legally
sell at a given price. For each price the quantity
available for supply is decreased.
As Figure 2 illustrates, the supply curve has
been shifted to the left. There are two effects – one
is intended and the other is unintended. The purpose
of the regulation was to decrease the number of exchanges.
The regulation might require the seller to
be licensed. The regulation might require the good or
packaging to meet certain standards. The regulation
might limit the time of day or the day of the week that
the transaction can occur. The intended consequence
of all regulations is to eliminate unwanted (by the government)
transactions. The regulation is successful in
this regard as the new market clearing quantity (Q’)
is less than the unhampered market clearing quantity
(Q*). As we can see from Figure 2, the unintended
consequence of the regulation is to raise the market
clearing price. The U.S. Health Care system is full of
regulations whose stated purposes are to improve the
quality of health care, but whose necessary side effects
are to raise the cost of health care.
Another government intervention with the free
market is the subsidy. A subsidy makes the price
appear smaller to the buyer than the actual transaction
price. The graphical effect is to shift the demand
curve up. Buyers will purchase at higher prices than
they would have without the subsidy.
Just as with the regulation, there are two effects
– on is intended and the other is unintended. The
purpose of the subsidy is to increase the number of
exchanges and the subsidy is successful in that regard.
We see in Figure 3 that the new market clearing
quantity (Q’) is greater than the unhampered market
clearing quantity (Q*). Unfortunately, the unintended
sided effect is an increase in market clearing price
from P* to the higher value P’. Contrary to popular
belief, neither Medicare nor Medicaid is an insurance
system. These government programs are large scale
subsidies for the purchase of health care. The programs
are successful at increasing the volume of
health care provided, but they both increase the cost
of health care by shifting the demand curve for health
care.
As the combination of regulation and subsidy
makes the cost of something, such as health care,
unaffordable to nearly everyone, government pulls
the price control out of its tool box of interventions.T h e effects of price controls are more complicated as
they do not shift the supply or demand curves.
Figure 4 illustrates a price control (grey line at
Price = PC) below the market clearing price. At the
price control of PC, there are both unsatisfied sellers
and unsatisfied buyers. Only QC sellers will still sell
at the price control of PC (dark dashed green arrow).
The difference between Q* and QC are unsatisfied
sellers and unsatisfied buyers. The unsatisfied buyer
at the margin is willing to pay price P’, which is even
higher than the market clearing price P*, due to the
lower quantity QC (light dashed green arrow). The unsatisfied
sellers can take advantage of the price gap
between P’ and PC by bundling goods or services.
Bundling can take many forms. The seller could offer
some worthless item for P’ and throw the price controlled
item in for free. The service of free delivery
could be offered. Combinations of goods whose value
add up to P’ can be offered to induce the purchase of
the price controlled item.
Price controls on labor have had a major impact
on the U.S. Health Care market. During World War II,
the U.S. Government imposed wage and price controls.
Employers bundled health insurance into the
compensation package to induce workers to take jobs
at the low wage control level. Employer based health
insurance became the norm for the U.S. health care
market.
Prior to Medicare, primary care physicians made
house calls. The house call has essentially disappeared
with Medicare due to low reimbursement for
the patient visit. The new model is an assembly line
office visit where expensive lab tests, imaging and diagnostic
procedures are bundled in with the patient
visit. It is very easy for physicians to bundle high cost
items with price controlled services due to the large
subsidies offered by Medicare.
The thoracentesis is illustrative of bundling to get
around price controls. In 1989, when I left academia
to enter private practice, I tried to offer thoracentesis
in the office. I discovered that the reimbursement for
a thoracentesis was less than the cost of the procedure
tray. The hospital was happy to let me do thoracentesis
in the Emergency Room, since the hospital
could add a high priced ER charge to the bundle. As
ER reimbursement declined, the hospital required an
ultrasound for ‘guidance’ whether I needed it or not.
Interventional radiologists decided to perform the thoracentesis
for, essentially, free by adding a CT scan
to the procedure. In 2014, it has become normal operating
procedure to admit the patient to the hospital
overnight, and add various imaging tests to the hospital
charges. The total fee for a thoracentesis has
gone from what should be less than $100 to more
than $1000.
The irony of price controls is that buyers at the
margin end up paying more than they would have
without the price control. As health care became less
and less affordable, higher and higher subsidies became
necessary for the average person which led to
even higher priced bundling. It is not at all uncommon
for the total fee of a procedure that takes an hour or
so to perform to be tens of thousands of dollars.
Health care is no longer affordable for the average
person in the United States. The primary cause
of this problem is government interference with the unhampered or free market. More interventions will
only make the problem worse.
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Received: 04/24/2014
Accepted: 06/10/2014
Reviewers: Benjamin Powell PhD
Published electronically: 07/15/2014
Conflict of Interest Disclosures: none