Micro and Macroeconomics of Healthcare Markets

Introduction: Supply, Demand, and Healthcare Complexity

The classical economic principles of supply and demand make sense even on an intuitive level. As price goes down for most goods and services, demand increases. As prices go up, demand decreases. Similarly, for providers, decreases in price reduce the incentive to supply goods and services while increases in the prices consumers are willing to pay increase such incentives. Even in abstract theory, however, there are caveats to the laws of supply and demand. The demand and supply of certain goods and services are more elastic than others. Certain items may be difficult to stockpile even when prices are low (such as fresh doughnuts versus a sale on paper towels). It can also be difficult in the short term — and sometimes even the long term — to respond to price increases or decreases (such as the challenge of eliminating the cost of commuting by car in response to a sudden spike in gas prices). With healthcare, however, the impact of economic principles is even more complex.

Economic Theories and Principles in Healthcare Markets

Theoretically, "in a free market, goods and services are allocated through transactions based on mutual consent. No one is forced to buy from a particular supplier. No one is forced to engage in any transaction at all. In a free market, no transactions occur if a price cannot be agreed" (Ladd, 2017, par. 4). But healthcare consumers are a captive market: when someone is sick, he or she cannot feasibly cut back on healthcare costs when their life is at stake. Additionally, the existence of a health insurance market isolates the healthcare consumer from the potential costs of the transaction. The patient is often unaware of the costs of a procedure until the bill between the insurance company and the provider has been negotiated. Billing is completely nontransparent at the immediate point of service delivery. Furthermore, while in the theoretical free market the consumer can evaluate the relative quality of a good or service based on price, healthcare consumers often lack the knowledge to assess whether a particular service is even necessary. "Absent a competent regulatory scheme, patients, at the moment in which they make their insurance purchase, have no way to be certain which provider will actually deliver on their promise" or whether the physician is being transparent about the patient's full medical needs (Ladd, 2017, par. 9).

The use of health insurance can create both over- and under-consumption of healthcare and generate significant inefficiencies in the marketplace. For example, with a fee-for-service model — which is typical of 86% to 95% of providers — physicians are "paid for each individual test, procedure, and treatment they provide," creating an incentive to perform more tests and more costly procedures regardless of whether the patient will actually benefit, according to the principles of evidence-based medicine (Pearl, 2013, p. 1). Although this conforms to the laws of supply and demand in the sense that higher payments result in a greater supply, an increase in supply does not actually create an optimum equilibrium point in the marketplace in terms of patient health. Furthermore, patients with more generous health insurance are more inclined to consent to additional and costlier procedures, even when they do not necessarily sustain the maximum benefit from them.

For example, if a patient with a generous employer-provided health insurance plan is recommended a particular screening procedure, he or she will likely consent to it. In contrast, a patient with a high-deductible plan with high copays will not, because he or she will have to pay more of the cost — regardless of actual medical need — unless that need is immediate and dire. Some healthcare plans also reimburse physicians at higher rates, while Medicaid (the government insurance program for individuals living below the poverty line) and Medicare (the government insurance program for the elderly) are notoriously much lower, which can again create an economic incentive to perform fewer procedures. With the inefficiencies of the fee-for-service model in mind, insurance companies are endeavoring to reward quality of care and outcomes, and also to limit the amount of money physicians can earn providing certain services. However, this can have an equally negative effect of reducing the incentive to provide appropriate care due to inadequate reimbursement. When patients postpone treatments because of cost in the short term, this can generate a greater need for care in the long term.

For-Profit vs. Nonprofit Healthcare Institutions

The inefficiencies and inequalities inherent to the United States healthcare system are why many advocate an emphasis on not-for-profit versus for-profit healthcare. For-profit institutions are beholden to shareholders to generate a profit, while not-for-profit institutions are not and operate under the law as charitable organizations. Not-for-profit institutions must invest all profits back into their facilities and carry no other financial obligations. "In theory, for-profit hospitals should operate with more zealous attention to business objectives than nonprofits because shareholders have their money on the line" (Cheney, 2016, p. 1). However, for-profit institutions must still remain solvent, and they still employ providers who depend on the organization for their livelihoods.

Theoretically, there is also, among for-profit institutions, a greater incentive to prioritize more profitable tertiary care and to focus on attracting patients with private insurance plans that offer higher rates of reimbursement. Yet the data supporting this is mixed, since there is no clear indication that "for-profit hospitals are posting higher operating margins than their nonprofit counterparts" (Cheney, 2016, p. 1). Both institution types clearly have an incentive to offer quality care in order to attract more patients — either to serve their mission in the case of nonprofits, or to grow revenue in the case of for-profit institutions — although the nature of the incentive structure is different in each case.

Conclusion

Healthcare markets deviate from classical economic theory in fundamental ways: captive demand, information asymmetry, third-party payment, and politically determined reimbursement rates all distort the incentives that ordinarily govern supply and demand. Neither the for-profit nor the nonprofit model has proven definitively superior in delivering efficient or equitable care. Policy interventions such as the ACA have addressed some market failures while introducing new tensions. The challenge of maintaining a largely for-profit healthcare system that adequately addresses the needs of all Americans remains daunting.

References

Blumenthal, D. & Collins, S. (2017). Where both the ACA and AHCA fall short, and what the health insurance market really needs. Harvard Business Review. Retrieved from: https://hbr.org/2017/03/where-both-the-aca-and-ahca-fall-short-and-what-the-health-insurance-market-really-needs

Cheney, C. (2016). Differences between NFP and for-profits are marginal. Health Leaders Media. Retrieved from: http://www.healthleadersmedia.com/finance/differences-between-nfps-and-profits-are-marginal#

El-Sayed, A. (2012). Five reasons free markets don't work in healthcare. The Huffington Post. Retrieved from: https://www.huffingtonpost.com/abdulrahman-m-elsayed/health-care-market_b_1405396.html

Ladd, A. (2017). There is never a free market in healthcare. Forbes. Retrieved from: https://www.forbes.com/sites/chrisladd/2017/03/07/there-is-never-a-free-market-in-health-care/#1d078d3c1147

Pearl, R. (2017). Healthcare's dangerous fee-for-service addiction. Forbes. Retrieved from: https://www.forbes.com/sites/robertpearl/2017/09/25/fee-for-service-addiction/#46a71759c8ad