Health care is a complex issue. A broad range of services are involved — from primary care to surgery to rehabilitation. Many different players are involved in the provision of health care: physicians, nurses, technicians, pharmacists, therapists, administrators, insurance companies, and hospital management. In addition to a financing mechanism, a health care system requires a trained and adequately paid workforce, quality medicines and medical technologies, and functioning facilities in which to deliver care.
People want the best possible outcome for their health and well-being, and they want to ensure access to health care services. However, they also have varying expectations about the relative effectiveness of component health services in preserving or improving their health. This uncertainty, combined with rapidly rising costs and unexplained variation in the use of services by different providers for apparently similar patients, creates the context in which health care decisions must be made.
In economic terms, the optimal level of health care expenditures depends on the marginal impact of each service on utility. To determine the marginal impact, one must calculate the demand for each service by taking into account the cost of providing that service as well as the benefits to health and welfare accruing from the use of that service.
But the marginal effect analysis is not without its problems in the case of health care. First, it assumes that the health care market operates like a normal goods market with profit-maximizing firms supplying each good at its long-run marginal cost. In fact, the health care industry is dominated by highly regulated non-profit and not-only-for-profit organizations that are unlikely to operate in a completely profit-maximizing manner. It is therefore impossible to construct a supply curve for health care services that represents the opportunity cost of providing them.
The second problem with the traditional marginal analysis is that it ignores positive externalities from the production of health care services. A key concept in the economics of public goods is the existence of “option value.” For goods and services that are purchased infrequently, for which there is uncertainty about future demand, and for which there are high costs to resume production if they are curtailed, the option value may be higher than the current period marginal benefit.
In the case of health care, these externalities include the satisfaction of individual preferences for medical services, the preservation or improvement of social wellbeing, and the availability of those services to all members of society. In addition, a societal concern with the possibility that a medical treatment might have negative side effects warrants some degree of public subsidy. All of these externalities are relevant to the optimal level of health care spending, but a careful review of economic theory and evidence suggests that a government monopoly for financing and provision achieves a less efficient allocation than would be obtained from a well-designed private market system.