Can health care work in a free market?

Clare Li explores the definition and condition of a ‘perfect free market’ in traditional economics, before assessing the feasibility of those conditions in the health care market.

A market is an adjustment mechanism that allows the gathering of consumers and suppliers together to exchange goods and services at an agreed price[1]. In traditional economics, a perfect free market is able to adjust with price and quantity signals so that buyer and consumer satisfactions and wellbeing at a given level of resource can be maximised. In such a market government intervention is an inefficient allocation of resource and unnecessary[1].

A perfectly free health care market requires the satisfaction of a number of crucial conditions on the demand and the supply sides of the market. On the demand size, there is perfect certainty, the consumer knows when their health wants will arise, and they can plan ahead and seek out perfect knowledge on what they want and where to secure the best prices. A perfect market also requires consumer sovereignty, in which the consumer has the ability to rationally judge and make decisions based on the perfect information available on the cost and benefits of the healthcare. They only purchase when benefits are greater than costs. Under the circumstance where consumers have to rely on the advice of agents to obtain perfect knowledge, agents act free of self-interest. In a perfect market there are also no externalities, i.e. one’s health cannot be affected in a positive or negative way by others’ consumption of health care services. On the supply side, supplier has perfect knowledge of demand and costs, there is no barrier to entry and there are many small providers, each with no market power, so that supply strictly follows to meet demand[1].

All of those conditions for a perfect free market are difficult to meet in health care. On the demand side, while some minor recurring health problems such as shortsightedness and non-acute elective surgeries can be planned, the occurrence of many acute or major illnesses is uncertain[2]. Consumers also do not have perfect knowledge[2]. When a health problem arises, consumers often lack experience due to infrequent experience. It is also difficult for consumers to become fully aware of their health status, as it requires  understanding symptoms of illnesses, the association and causation of diseases, while the probability of occurrence depends on multitude of factors including age, gender, family history/genetics, pre-existing conditions, lifestyle. Once illness arises, information on appropriate care pathways; services available; and level of quality services may not exist or be too complex for consumers to digest. This leads to the breakdown of consumer sovereignty.

Consumers also need to rely on agents to provide them with information as well as helping them make decisions. In the healthcare market those agents are almost always the sellers/supplier of services e.g. doctors. This places asymmetrical power with the supplier. Not only are suppliers given the role of informing patients, they also have significant influence on consumer’s decision making. When agents’ remuneration is directly tied to the information they provide and the decision they can influence, particularly under the Fee for Service payment model, conflict of interest and moral hazard arises breaking down the perfect agent condition[2]. In healthcare, there are also externalities[2], where an individual benefits despite not consuming any health services (e.g. herd immunity from immunisation) or is harmed as a result of others’ consumption of health services (e.g. anti-biotic resistance), which further breaks down market forces of price and consumption quantity, where positive externalities reduces the optimal consumption of health care, and negative externality leads to excessive consumption.

On the supply side, crucial conditions also fail in the healthcare market. Under the perfect free market there will be no barrier of entry and a large number of doctors to compete with each other purely on price[1]. Regulation and quality assurance on the supply side will be difficult to enforce, this can and does lead to mistakes and some may even be fatal.  The moral obligation of society imposes licensure[2] requiring supplier to hold minimum qualification and training to protect consumers’ safety.  This inadvertently gives more market power to suppliers allowing suppliers to charge prices higher than the value of the care.

Leaving consumption of health care to the free market can result in a significantly higher price of care, or no access of care in some rural and remote areas. In areas where population is sparse and people are more likely to have less purchasing power but greater burden of disease. The cost of providing health care in rural and remote areas can be significantly higher due to higher living costs, transport costs, telecommunication costs and difficulties in attracting health professionals at urban remuneration rates[3] [4] [5]. Health care deemed by free market forces will likely be offered at a significantly higher price and be very limited.

Leaving health care to the free market can also result in inequity between various groups e.g. affluence, racial and ethnicity. Disadvantaged groups may be more costly to service may likely receive less information and services and utilise less care. Some evidence of this is demonstrated by the US healthcare market, where there is an increasing proportion of non-elderly persons without insurance coverage[6] and in particular less access to health care for certain ethnic and racial groups[7] [8].

Health care operating in a free market can lead to inefficient use of resources.  Barriers to entry and asymmetry of knowledge not only allow suppliers to charge higher than the perfect market price, but also create a supplier moral hazard. Some evidence of this is supply-induced demand where care is provided with no value or little value relative to its costs, in some instances even causing harm to consumers[9]. Uncertainty in healthcare consumption creates the need for private health insurance or universal health insurance, which changes market price signals.  This creates consumer and supplier moral hazard and leads to over-consumption of healthcare when the price to the consumer is lower than the market price. This can be evidenced by comparing the utilisation rate of primary care services under bulk billing with private billing systems, and the RAND study examining the relationship between utilization and co-payments[10].

The failing of many crucial free market conditions in health care points to a strong need for government intervention[2]. Unlike many other products and services, health care is needed by every one and is considered a basic human right in Australia[11]. Mistakes in health care can be significant and irreversible. Asymmetry of knowledge and imperfect competition leads to significant power imbalances. There is a strong need for government intervention to maintain the quality of providers; to act as a counter-balance power to the powerful suppliers of health care in negotiating and controlling prices; to allow access of basic health care to the poor, disadvantaged, and those residing remotely, which in a free market might not have been provided.


[1]Markets and health care: Introducing the invisible hand – Chapter 2, In Economics of Health Care Financing. The Visible Hand (2nd Edition) Donaldson C, Gerard K, Jan S, Mitton C, Wiseman V. Palgrave Macmillan NY, 2005

[2]Market failure in health care: justifying the visible hand – Chapter 3, In Economics of Health Care Financing. The Visible Hand (2nd Edition) Donaldson C, Gerard K, Jan S, Mitton C, Wiseman V. Palgrave Macmillan NY, 2005

[3]A program to increase the number of family physicians in rural and underserved areas: impact after 22 years. Journal of American Medical Association 1999 January 20, 281(3): 255-60. Rabinowitz JK, Diamond JJ, Markham FW and Hazelwood CE.

[4]The rural vs urban practice decision. MSJournal of American Medical Association Jan 2, 287(1): 113. Rabinowitz HK and Paynter NP.

[5]Where we live: health care in rural vs urban American. Journal of American Medical Association 2 Jan., 287(1) 108 2002. Van Dis J.

[6]Prospect of expanding health insurance coverage. Northern England Journal of Medicine 2001, 15 March, 344(11): 847-52. Schroeder SA.

[7]Effects of race and income on mortality and the use of services among Medicare beneficiaries. New England Journal of Medicine. 1996 September 12, 335(110): 791-9.

[8]Racial disparities in the quality of care for enrollees in medicare managed care. Journal of American Medical Association 2002 March 13; 287(10): 1288-940.




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