Why is the us healthcare market referred to as imperfect
Market.Imperfect.Neg.Externality.U2.T2
hi this is Ron SIPP cick in this
particular segment we're going to take a
look at what is called a market
imperfection in this case the market
fails it does you go what does it fail
at it fails in operating at the optimal
output level in the optimal price and so
in this case there'll be a role for
government to play in helping the market
find its optimal price and quantity the
particular example we want to look at at
this point is something called a
negative externality a negative
externality is actually a case where a
cost is imposed on an innocent third
party for instance let's think about the
case of air pollution let's talk about
perhaps an electricity company a company
that is taking coal or some other input
natural gas and producing electricity in
that particular case if the electricity
plant releases air pollution into the
air rather than taking the steps to
properly control that pollution it
imposes a cost on third parties people
that have to breathe the air
perhaps incur healthcare costs or clean
cleanliness costs for instance you know
cities where there's lots of air
pollution you have to wash your car more
your house looks dingy or and dirtier
besides the fact that things are just in
general dirty people incur are incurring
health health costs as a result of
breathing that that dirty air those
particulates that are in the air so
pollution in this case is really from
the standpoint of the electricity
company low-cost or no-cost disposal of
a bad smoke is a bad it's it's a
byproduct of the production process in
producing electricity you're going to
get a byproduct called smoke
particularly if you're using something
like coal to to actually produce the
electricity and that bad imposes a
negative externality or an external cost
on third parties so let's go ahead and
move down and we'll take
look at this and we'll also take a look
at how government can help correct this
problem before we look at that though we
need to understand what the problem
actually is so in this case what I've
done is drawn a crude model of the
electricity production process the coal
is input an input of course there are
other inputs that go into making
electricity but coal is of particular
interest because it's a relatively dirty
input the electricity company takes the
call in the process of generating
electricity it's going to be releasing
smoke into the air
this smoke of course is going to go down
and it's going to actually hurt people
who breathe it okay and the health care
costs or cleanup costs of this smoke are
imposed on people who are not really
directly a party to the transaction
notice that smoke is actually a
complement in production with respect to
electricity but the problem is smoke is
a bad not a good so in this case we're
getting complements in production we're
getting a good called electricity but
we're also getting a bad called smoke
now if the electricity company were
serious about taking care of this smoke
it could put a scrubber on this
smokestack and this scrubber let me just
go ahead and spell that out the scrubber
could catch many of the particulates
that are going up in the air and could
capture those particulates and then of
course that those that that it's like a
big cigarette filter that could be
cleaned out maintained of course in
pulling the particulates and literally
tons of these particulates would be
caught in this in this scrubber these
particulates would have to be trucked
away taken to a landfill improperly
disposed of so the the point is when we
run a scrubber on a smokestack is very
very expensive this is a very expensive
treatment of the smoke and the point is
these costs have to be borne by the
electricity company and ultimately
passed on to the consumer so the
polluting electricity company
avoids these costs and basically and
passes these costs on to third parties
by not absorbing these costs into its
cost structure the market is the
electricity market is actually under
costing which ultimately means under
pricing electricity and ultimately over
producing it and we'll see that in just
a minute
so again the main idea to pick up at
this point is that pollution is
basically no-cost or low-cost disposal
to the electricity company with those
costs being imposed on innocent third
parties who have no way to remedy that
that problem unless government steps in
alright so let's go ahead and move down
and and see how this is shown in supply
and in the world of supply and demand so
here is our here is our electricity
market let me go ahead and switch my
color there here's the electricity
market and there are suppliers of
electricity utility companies and there
are demanders of electricity all the
users both household users and
commercial users now the problem is the
supply curve for electricity is only at
this point accounting for what we call
internal costs internal costs are those
costs that are borne directly by the
firm in any internal cost is ultimately
passed on to the consumer in the way of
price so all internal costs must be
passed on to the consumer and and the
reason for this is electricity companies
are profitable those shareholders
require that they earn a profit so the
electricity company is not only going to
pass on all of its internal costs but
have to earn some sort of profit on top
of those internal costs so ultimately
the costs of electricity are borne by
consumers that's a key idea consumers
ultimately pay all of the costs of
electricity because electricity
companies are profitable if electricity
companies were not
they wouldn't stay in business and the
government would have to step in and
subsidize them in that case it could be
and we see this in certain countries
where there's a lot of command we see
government controlled utility companies
where the utility companies actually do
not cover all of their costs in other
words they do not pass all of their
costs on to consumers which means they
need to be subsidized by the government
what I'm assuming here is this is a
market system where all of the
electricity costs must be passed on to
the consumer so the electricity user
ultimately covers all of the costs of
production the problem is these internal
costs are under estimating under
estimating the true costs of production
after all the electricity companies are
not properly disposing of their waste so
if we were to account for all of the
costs of producing electricity the
supply curve for electricity would be
where it would be much further to the
watt to the left and so notice I now
draw sorry about that let me go ahead
and erase that with my racing function I
can get it to work I think I can so let
me go back to my pen and notice I've
introduced a new supply curve in here
this is called s2 and asked to accounts
for internal internal and external costs
so in other words what I'm now including
is not only internal costs but I'm
including the external costs that have
been imposed on third parties so if this
market were to account for all of the
costs of production where would its
supply curve be it would be further to
the left external costs are these
negative are these negative
externalities okay
so external costs equal negative
externalities notice that by imposing or
including these external costs on the
market or int into the cost structure
the supply curve is further to the what
it's further to the left which means
what the price is what the price is
higher and the quantity is what the
quantity is lower so in essence if we
forced consumers to pay for the cleanup
costs of electricity in other words to
pay for the proper disposal of the
byproducts the smoke or whatever that
comes out of electricity production
consumers would have to pay more for
electricity and not as much electricity
would be consumed which says something
very very important cleanliness is
costly let's go ahead make a note of
that that's that's worth noting I know
some people think cleanliness is next to
godliness
I'm not going to make that argument all
I'm saying is cleanliness cleanliness is
costly so if you want a cleaner
environment if you want a cleaner
environment
you basically have to incur higher cost
in other words cleanliness is what
cleanliness
you could say this - cleanliness is
scarce oh yeah yeah yeah in a civilized
world where people mess things up dirty
things up if you don't think you do this
think of your bedroom right now
or think of your kitchen or think of
other areas in your home as you use your
home you inevitably make things dirty it
takes time but not really time time
devoted to cleaning up its time not
devoted to other things time not devoted
to to maybe something you'd like to do a
hobby or something or it's time not
devoted to working per se at a job where
you could earn income so keeping your
house clean means you give up
something which means cleanliness is
costly it is impossible to live in a
civilized world where there are human
beings in close quarters without
imposing without making things dirty and
without needing cost to be incurred to
keep things clean okay cleanliness is
costly and the obviously in a market
setting where companies are producing
things they're going to be making a mess
when they produce things and some of the
things that are produced electricity for
instance is very very dirty very dirty
now America has even with coal done a
much better job than some some other
nations with coal we hear the horror
stories for instance in mainland China
we're walking around Beijing the capital
of mainland China when you walk around
for a day 24 hours or so you're on the
ground in mainland China for a day
you're gonna breathe the equivalent of
three to four packs of the smoke just in
the air you're gonna it's it's the
equivalent of smoking three or four
packs of cigarettes it's that dirty and
all sorts of measures need to be taken
by the citizens of Beijing to not
breathe this stuff they have to wear
breathing apparatus and they have to
limit the amount of time they spend a
walking and you know working in certain
areas of the city
it's extremely the air quality in
Beijing is extremely low why because
companies are not required to deal with
their external costs rivers in Beijing
extremely dirty why because companies
are not required at least to a two to
the same standard as America to keep to
keep to keep pollutants out of the
waterways so waterways in Airways are
just terribly dirty and this is this is
the cost of this is a cost inherent with
manufacturing manufacturing heavy
manufacturing say what you will about
made in China but making manufacturing
in China means less pollution in America
and until China begins to
force these companies to impose until
the the governments of China begin to
force these companies to clean up and
keep their air and waterways clean China
will always have an advantage because in
America we force manufacturers to
produce much more cleanly than the
Chinese do so manufacturing in China you
automatically have a cost advantage
because there's not as much pressure on
you to to produce cleanly okay so let's
go ahead and now look at the question of
what what what can government do what
can government do about this problem and
there's a number of number of options
here so this is going to be a case where
government has a role to play in causing
the market to operate at the right at
the at the right output rate now let me
just let me back up a second here I'm
getting all excited and getting a lot
ahead of myself where should this market
operate this market should operate where
this the optimal the optimal quantity is
QE to the optimal price is PE - why
because this price and this quantity
account for all of the cost of
production so if the market is allowed
just to operate on its own what will it
do it will what it will under price it
will under price so a free market the
free market will under price under price
electricity and the free market will
what the free market will over produce
electricity in this case
yeah well that's that's not bad that's
good cheap electricity lots of it that's
good but keep in mind electricity in
this case is a high pollution product so
what we're saying is we're under pricing
and we're over producing a high
pollution product a very product that is
imposing external costs
on third parties that is not desirable
so point one is is is a isn't is a
market outcome market outcomes sorry I'm
really have a lot of room there that is
what we would call sub optimal
suboptimal means less than optimal the
optimal market outcome the optimal
market outcome would be point two
because we're properly pricing and
producing electricity okay all right so
what can government do to move us from
point one towards point two what can
government do to increase the price of
electricity reduce the quantity in other
words shift the supply curve to the
right let's take a look at that
one option would be regulation so let's
write that out okay and what black there
there we go so government regulation of
the polluter so this this is relatively
straightforward increased regulations in
other words impose a regulation on the
polluting utility company say to the
utility company look you must scrub
scrub your smoke and we expect it to be
at a certain level of cleanliness which
we are going to establish will determine
the health standard you have to meet the
standard if you don't meet the standard
we shut you down so this increase in
regulation does what it's going to
increase the cost of production and this
electricity company is going to need to
put a scrubber on its smokestack this
increases the internal cost of
electricity the effect of that is to
decrease the supply of electricity okay
this of course is a leftward leftward
shift this leftward shift in electric
and and the electricity supply curve
does two things yet what increases PE
and decreases QE which is exactly what
we're looking for alright so basically
what we've done is we've converted this
is very important we have converted
external costs to internal costs okay
now
there's a second a second method that
governments often use this is less
severe gives gives businesses a little
bit more choice in how to deal with the
problem but you could you could tax the
polluter you could tax the polluter it's
been write that out what I mean tax the
polluter well we impose a tax on the
basis of how much the firm pollutes
the more you pollute the more you get
taxed the less you pollute the less you
get taxed and what we do is we take
measurements we measure your air quality
which is fairly easy to do you can set a
standard and we can set a set a no tax
standard you know there's a certain
level of pollution might be acceptable
but anything above a certain level would
require you to pay a tax on the amount
you pollute well taxes do what they
increase the cost of production they're
an internal cost and again if you
increase the internal costs of the firm
you decrease the firm's supply which
again is leftward and that has the
impact of driving the price of
electricity up and decreasing the
quantity this is almost equivalent to
what we'd call a sin tax we're basically
taxing the polluter for bad behavior and
we let the beat that we let the polluter
behave that way but we make them pay
more for for sinning for polluting if
you will so this is the syntax now you
can imagine here that if I mean taxed on
the amount I pollute I have an incentive
to try to figure out ways to produce
without polluting and avoid these taxes
whenever you impose taxes the person
being taxed looks for ways to avoid it
so this is going to encourage the
polluter to look for ways to produce the
product without tax without polluting in
essence you're going to convert again
external cost
to internal costs you know you're
encouraging the firm to come up with
methods to avoid polluting and that is
going to lead them to incur costs
internal costs that reduce pollution and
it has you know roughly the same effect
as regulation it's not a severe in that
the regulator the regulated firm is
forced to abide by the rule where the
taxed firm can they actually choose to
pollute but has to pay more to pollute
okay but nevertheless you've created an
economic incentive for the firm to stop
polluting there's a third option that I
want to look at and let me go ahead and
move move this up a little bit and that
third option would be to create
government could create a market or what
are called eces EC's our environmental
credits and buy credits and again the
government is involved in all three of
these here the gut let me just put the
we just put a little government creates
a little edge in there the government
creates a market for environmental
credits you go what what do you mean by
that all right let me show you an
example here this is a very primitive
example of this very basic example but
just give you a kind of an idea let me
go ahead and use an example here suppose
there are two companies there's ABC
company and ABC is a dirty company and
it's a relatively a messy producer say
there's a company XYZ company and XYZ
company is a relatively green clean
company okay green and clean all right
so what do you mean ABC is dirty it
pollutes at a relatively high level so
say it's polluting its Stan
pollution is ten parts per billion 10
ppb so this is a measurement of
dirtiness the higher the measurement the
worse the pollution so 10 parts per
billion 10 10 particulates per per
billion of this particular thing that we
don't want in the air ok and then say
say that XYZ company is a relatively
clean company in that it only pollutes
at 6 parts per billion so it pollutes
but it pollutes much less 40% less than
ABC the dirty company ok let's say that
the government has determined a standard
and the standard is let's say 8 parts
per billion
so the standard goes all the way across
and that's 8 parts per billion and
that's called the standard and that's
considered satisfactory so if you hit
the standard you're ok you're not in
trouble but if you're above the standard
you're in trouble so what do we got here
we've got we've got ABC company which is
what 2 parts per billion above standard
we've got XYZ company which is what 2
parts per billion below standard so XYZ
is you know making the government very
happy because it's relatively clean
compared to standard ABC is not making
the government very happy because it's
actually 2 parts per billion above
standard what we're going to do is we're
going to penalize ABC company for its
dirtiness by requiring it to buy it will
have to buy 2 environmental credits why
it essentially is 2 parts per
in above standard it now effectively
must buy it owes to environmental
credits in essence it is its dirtiness
has created a situation where it's in
debt it's in debt to society whereas XYZ
company because it's 2 parts per billion
below standard it is in a position where
it may sell to environmental credits in
other words if they're like they're like
little gold stars XYZ gets two gold
stars for being below standard and has
the right to sell these as credits to
some dirty firm so you can see what
happens here I've made this very simple
and straightforward XYZ is in a position
to sell these to environmental credits
to another producer in its area who
requires to environmental credits so in
other words X Y Z can profit from its
cleanliness and ABC incurs a cost for
its what for its dirtiness and this of
course creates a wonderful incentive you
reward clean companies and allow them to
sell environmental credits and you
effectively punish dirty companies
requiring them to pay for their
dirtiness and in essence you create an
incentive for dirty companies to get
cleaner and create an incentive for
clean companies to get even cleaner and
of course if everyone is below standard
then you can simply lower the standard
alright so if both of these companies
and all other companies in this
particular geographic area who are who
are polluting the air if everyone's
below standard that means a lower
standard is appropriate you can set a
lower standard when everyone can beat
standard and this of course creates
market pressure on both types of firms
to get cleaner the dirty firm must get
cleaner so it doesn't incur costs and
yet and the clean firms have an
incentive to be cleaner because they can
profit from their cleanliness so this is
a you know very primitive now these
these environmental credit systems can
be configured in different ways but this
is just a very simple example of how one
could work and you can see that this
creates market incentives so let's make
a note here you just go ahead and change
the color here the EC system which is
effectively a government created market
creates an incentive to be what to be to
be clean alright so again the issue is
the issue is negative externalities that
in the process of producing something
you're going to make things dirty if the
firm incurs those costs and embeds them
in the price of the product
there's no than those cost being the
cleanup costs there's no problem the
market operates where it should but if
firms fail to internalize the cost of
cleanup and impose external costs on
third parties which let's face it many
firms do they do it either intentionally
or inadvertently then the government can
step in and cause the market to actually
operate in a better place by forcing
companies to address their external
costs and this again is called the case
of negative externalities now rather
than drawing drawing this I'm just going
to mention that governments can
obviously over regulate over tax and and
over compensate for pollution and that's
rather simple to see let me just go
ahead and move us up back back up to our
to our diagram that and I'm not going to
draw
this but but I can I can just go ahead
and show you what it looks like by
looking at this model the government has
obviously overreacted don't don't do
this to your picture but the government
has overreacted if it pushes supply too
far to the right so if it pushes supply
over here to s3 it's over compensated
for external costs and it's pushed
prices where it's actually pushed prices
too high and has pushed the output rate
too low now it's distorting the market
so so long as government doesn't over
regulate an over tax it benefits the
market but when the government over
taxes and over regulates it it distorts
the market so the argument here is going
to center around how big are those
external costs and that's that that's
the problem how big are they how how
detrimental how how costly is a certain
type of pollution to third parties that
becomes the question and of course
science is helpful in trying to decide
this but there's still a lot of
uncertainty and it's still unclear how
certain types of pollution actually
affect affect people
so no easy task to figure that out so
governments will usually be either under
under performing not doing enough or
they'll be too heavy-handed which means
they're doing too much and again this is
usually because of a lack of information
it's difficult to assess how large those
external costs are okay that wraps up
our our our study of negative
externalities
