Health Care Costs, Externalities, and the Failures of Markets

The classic example of markets failing to price things is where a product creates pollution. The idea is that the benefit of the use of the product is concentrated with the purchaser and supplier, but the negative impacts of the product or its use are spread across a broader population. For example, when purchasing gasoline for your car it is very straight forward for you to understand the benefit of being able to use your vehicle and compare that to the price being charged by the supplier. However, unless you are more altruistic than many you probably don't factor in the extra carbon and carcinogens in the air which will negatively impact the environment.

The recent news about investors purchasing drug companies and significantly increasing the price got me thinking about the opposite circumstance where there are significant benefits for the broad population that don't seem to be taken into account by the market. From a purely economical standpoint the tactic is purely rational. There are barriers to entry for many drugs even after the patent expires, especially in the near-term, and significant demand for the product which increases with the severity of the disease. Given only that you would expect the producer to have significant pricing power as demand for the product would likely be inelastic and substitutes would not be readily available. 

However, the price set by the transaction between the producer and the consumer ignores positive effects for the rest of the public including that the disease is less likely to spread, a healthier population is likely to be more productive, and economic mobility would likely increase as health issues tend to be concentrated in lower socioeconomic brackets. Measuring these benefits is difficult as highlighted in a recent joint article between the Harvard Business Review and The New England Journal of Medicine, however if we are interested in properly balancing resources to production and consumption of health care it is something we have to try to do.

Even armed with perfect data for the net size of the positive externality it is unclear about how best to act on that information. Subsidizing health care combined with regulation of health care costs could solve for the issue with perfect information and decision making based solely on that information. However, in a world of government lobbying and imperfect information the subsidy is likely to be larger than the societal benefit due to the concentration of suppliers as compared to overall population.