Previously we discussed basic cost theory. The “market price” of something happens when a producer and consumer find alignment in their opportunity costs.
There’s a special kind of price that happens when production is in equilibrium with supply. It’s difficult to tell exactly what that price is — and impossible to predict — but still, we can imagine a situation where price is stable, and inventories are neither increasing nor decreasing. Let’s call that the “market-clearing price.”
The market-clearing price is not an intrinsic property of a good or service. Just depends on what consumers are demanding these days, and whether or not producers feel like satisfying that demand (they may or may not, depending on what it costs to produce, and what consumers are willing to pay).
It’s best to think of the market-clearing price as information, or even a signal. It’s a signal to producers to either get in on the business, or get out of the business. If inventories are decreasing, and consumers are bidding up prices, that’s a good time to get in. If inventories are building up, and prices are falling, that would be a good time to get out.
Here’s the problem.
Led by Medicare, which never met an economic law it wasn’t willing to break, most of the healthcare system relies on price-fixing as a means of controlling health-care costs.
As I mentioned previously, it’s impossible to know in advance what the cost of something is. The government is just guessing, basically. Whether the guess is above or below the theoretical market-clearing price has profound implications.
What if we fix the price of something below the market-clearing price? Essentially, we are sending a signal that people should get out of the business. And that signal is as accurate as any self-fulfilling prophesy can be. If producers keep piling on, the firms will wind up consuming more resources than they produce in the form of income. They will either starve, go bankrupt, or have to beg for subsidies.
Here, we have indirectly, and artificially limited supply. However we have done nothing about demand. Which, if anything, will go up due to the bargain-basement prices we have set. So we can expect shortages, with no mechanism to signal the market to produce more of that thing. Normally, rising prices would signal producers to jump into the pool. But the price can’t go up, because we fixed it.
What if we fix the price of something above the market-clearing price? Now, we are sending the signal to get in on the business. To make more of something. Again, we haven’t done anything to change demand. If anything, high prices will reduce demand. So the net effect is to build up inventory, and that process continues until something breaks. Which is a terrible waste of resources, which could have been put to better use making other things.
Private insurance companies have tools available to allow the marketplace to work. Medicare generally does not, although its copays and deductibles help some. Inasmuch as some “Medicare-for-all” proposals seek to do away with deductibles and copays altogether, we could find ourselves on a pathway toward market bedlam. In Part 3, we will discuss how Medicare wreaks havoc in the healthcare marketplace.