Market failure is the failure of markets to achieve allocative efficiency. The market failure in healthcare industry is caused by several factors like the failure to take into account positive externalities (the external benefits occur when third parties benefit from the consumption/provision of the service), consumers not being the best judge of their own welfare and imperfect information (asymmetric information). There is also market dominance by healthcare groups which may lead to under-provision of the good/service and higher prices than would exist under conditions of competition. This also results in equity issues where the free market distributes the service only to those who can afford the service resulting in an exclusion of those who can’t afford to pay.
Healthcare industry provide general healthcare service and is a type of merit good as it generates positive externalities from consumption. Their consumption is socially desirable. Positive externalities are benefits to third parties not involved in provision or consumption of the healthcare service. A person will only take care of his own private costs (cost of the healthcare service to himself, purchase of medical insurance, loss of potential income) and private benefits (healthy and able to perform physical functions). He does not consider the positive externalities on others that would be generated by him staying healthy as well as doing productive work and not be a burden to the state if he is medically unwell. The social benefit from him staying healthy is the sum of private benefit faced by him and the external benefits to third parties. Positive externalities from provision and consumption of healthcare will lead to a divergence between private and social benefit.
Market failure is likely to exist because the positive externality is not taken into
account by the price mechanism. If healthcare were provided through the free market, private optimum occurs at Qe where MPB equals MPC but MSB > MSC.
However, the socially efficient level is where MSB=MSC at consumption Qs. Therefore, there are too few resources devoted to the consumption of healthcare services. There is under-consumption of healthcare because society values an extra unit of healthcare more than what it would cost society to produce it. Shaded area represents the welfare loss to society as a result of this under-allocation of resources. Society as a whole could be made better off if the current level of healthcare were increased to socially efficient level. (Qs)
Markets in the healthcare industry can also fail when the individual does not have sufficient information to recognise the future benefits of healthcare. It is necessary for individuals to know how much healthcare they should “consume” at different stages of their life. Many people are also indifferent when making health care decisions and they assume their health should they fall ill is a private matter and will not be a strain to others.
The healthcare industry is not competitive in nature, but dominated by one or two major healthcare groups. The start-up cost like for use of technology, equipment, employment of specialists, trained support staffs are huge barriers to entry. Under provision and high price would exist under conditions of an industry lacking in competition.
The free market can generate a distribution of income where people on low income are denied access to healthcare service considered ‘normal’ by a society. Thus, totally leaving the provision of healthcare industry to the free market can deprive those households in this category to be excluded from it.
Where the healthcare industry exhibit positive externalities that cause market failure, the government must attempt to intervene to ensure the above causes are eliminated.