Free Health Dissertations - These Changes May Be Achieved By Direct Regulation And/or Through Contracts
These changes may be achieved by direct regulation and/or through contracts (as per the internal market model). Alternatively, government could delegate responsibility for micro-managing the supply side to private institutions and require these institutions to compete on price and quality dimensions (as per the managed competition model). All potential solutions have costs and benefits and are discussed in subsequent chapters.
Economies of scale
Depending on the particular health service market in question there may be economies of scale on the supply side. As mentioned above, economies of scale occur in a market when long-run average costs decline over time and are generally associated with industries or sectors where there are high start-up costs before even one good or service can be produced. For example, because of the high capital costs involved in hospital construction it is likely that in rural areas it would be inefficient to have more than one hospital, as to do so would duplicate high fixed costs. This would be a waste of society’s scarce resources and thus allocatively inefficient (Farber, 1991). If government intervenes to prevent more than one hospital in a region then the problem arises that the hospital is a monopoly. From an economic perspective the problem with a monopoly is that it generally prefers to produce at a higher price and at lower output than in a competitive market. The result is economic inefficiency if consumers substitute away from the monopolist’s higher priced services to other services that are of a relatively cheaper price but in real terms cost more to produce (allocative inefficiency). There are also significant distributional consequences flowing from allowing an unregulated monopoly as there is a wealth transfer from consumers to the monopoly owners. A large wealth transfer means that consumers have not reduced their consumption in the face of price increases either by abstinence or through the consumption of substitutes (i.e. demand is inelastic). This will be so in the case of many hospital services as demand is likely to be highly inelastic and there are few realistic substitutes.
In response to the monopoly problem a government could regulate the price a monopolist charges to eliminate supra-normal (excessive) profits, and regulate and monitor the quality of services produced by the monopoly. Regulatory costs may be high, however, given that hospitals will have much better information than a regulator about their own costs and the quality of the services they supply. Some commentators believe that regulatory costs will outweigh any inefficiencies resulting from unregulated monopoly and recommend instead reliance upon competition for the market or a contestable market (Enthoven, 1978).
