Wednesday, April 30, 2014

Diminishing Returns in Healthcare

Many people are ignorant of economics. This sad fact leads to misguided beliefs with regards to how states should allocate resources. The problem has never been clearer than in healthcare.

Diminishing returns has to do with how the average cost of a good or service increases as the amount produced of the good or service increases. At lower levels of output, we experience increasing returns, meaning the average cost decreases. As output increases, we reach a point where the average cost starts to increase. This point is determined by our level of technology.

As an example, historically grocery stores were small. They provided the necessary goods people needed within a small community. As technology improved, both in the ability of consumers to travel further and in the ability of grocery stores to get and hold larger inventories, the average cost of larger grocery stores fell. This has lead to the rise of large stores like WalMart who is able to provide more goods than so-called mom and pop stores at lower prices.

How does this apply to healthcare? There is a natural progression from small hospitals who take care of the need of a small community to larger hospitals that have more specialized nurses and doctors. By serving more people, they take advantage of increasing returns and can care for more specialized needs.

But what happens if the state comes in and tries to increase the number of people they serve? Resources that should be directed to assisting in more specialized treatments have to be directed to deal with more generalized treatments. This is why in countries with socialized medicine, getting in to see a general practitioner is faster than in the US but the wait to see a specialist is much longer.

Since we are talking about government services, it is hard to see how the cost of medical care is higher. The cost of devoting more resources to general practice is the forgone ability to serve those with more specialized needs. Since prices are set by government for these resources, we cannot accurately measure the true costs this imposes on society in dollar terms.

When resources are allocated by market forces, meaning according to the needs of the people, the way firms increase profits is by investing resources in improving technologies. Under government directed healthcare, resources are misdirected and investment is misallocated due both to the inefficiency of government due to lack of prices and the effect of diminishing returns.

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