Markets for Widgets Result in Low Costs and Efficiency
WidgetWorld, if it can, should lower its price to at least match Widgets-R-Us. Widgets-R-Us can make a widget for $90, and WidgetWorld for $92 (they're not as efficient). WidgetWorld can lower its price to $93 and still make a profit--so they do, and their market share begins to rise. That is, until Widgets-R-Us drops their price to $91. WidgetWorld must now either get more efficient or go out of business. This is good for everyone...prices are low, and if you can't produce efficiently, you go out of business.
WidgetWorld goes out of business. Widgets-R-Us can now charge whatever they like without fear of being undercut--so they raise their price to $115, and stop worrying so much about efficiency. People with little money go without widgets (even though widgets make wangles work--and you can live without a working wangle, but your life will suck.) They also don't have to treat their widget-making employees quite as well. This is a monopoly. Bad for consumers, bad for employees, although it's friggin' awesome for Widgets-R-Us shareholders and executives.
Happily, Wally, seeing an opportunity, starts a new company--Wally's Widget Emporium. Wally's makes widgets for $90--just like Widgets-R-Us used to. Wally starts to sell for $100 and starts making money hand-over-fist, as consumers flee Widgets-R-Us. But almost overnight the price of widgets drops to $91 as the two companies compete--and employee conditions improve at Widgets-R-Us. Poor folks can afford widgets for their wangles again, and their lives are less bad.
As Wally's and Widgets-R-Us continue to compete, they find more and more efficient ways to make widgets, and prices are continually driven to an equilibrium point just above the cost of production. (If it gets too high above, someone else will come in and make more widgets, driving the price down. If it gets too close to cost of production, the profits drop and the manufacturers will start making something more profitable; widget supply will drop, and prices will rise.)
This is almost miraculous! The widget market, without anyone consciously trying to make it happen, maximizes efficiency and minimizes costs. What features of the market make this possible? For now, I'll just identify some of the features. In subsequent posts, I'll explain why most of these features either do not or cannot exist in markets for healthcare.
Features of an efficient market that needs no government influence:
- Informational equality.
- Low barriers to entry.
- Low switching costs.
- Elasticity of demand.
- Few externalities.
Informational equality means that it's possible for me to accurately assess the quality of widgets, and know the price ahead of time. Widgets can be compared side-by-side, so Consumer Reports can competently and accurately assess quality for me.
Low barriers to entry. We were rescued from the widget monopoly when Wally's came in to compete with Widgets-R-Us. This was only possible because Wally could start making widgets without having to be a mega-billionaire (think about starting a car company). He also didn't have to face massive regulatory hurdles (think about starting an airline.)
Low switching costs. The market works well because it costs me nothing to switch from one brand of widget to another. But what if the companies made widgets with different numbers of dongles? If I switched widgets, I'd have to get a new wangle--and I love my wangle! The two companies can raise their prices, knowing that I won't leave them unless there's a BIG difference in price.
Elasticity of demand. If the price of widgets goes too high, I can always just not buy one. I won't like it, but I can live without it, and I can wait around until there's a sale. If enough people stop buying, then the companies will drop their prices until we start buying again.
Few externalities. Externalities are effects of a transaction that are not measured by the parties to the transaction. Externalities can be positive or negative. When I buy a widget, it appears to affect only me and the widget-maker. There's no reason for the government to interfere, right? Right. But what if widget manufacturing creates a lot of pollution? Well, my one little widget doesn't contribute much to that problem--and I don't personally live near the plant--so I don't care. And the widget-maker, in making one more widget for me, reasons similarly. What's it to him if there's a little more pollution? Pollution is a common example of an externality. By definition, market actors (buyers and sellers) don't care about externalities.
We sometimes want government to step in and account for the externality. For example, the government should regulate the widget-makers' pollution. In doing so, the government will increase the cost of production and thus the price. But if government does it properly, then all it's doing is making sure that widget-buyers are paying the true cost of widget production (the direct cost, plus the cost of keeping the environment clean.) Externalities are key to understanding when government regulation or control is justified.
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In later installments, I'll show why these features, which are required for market efficiency, minimizing cost, and measuring the true cost of goods, apply poorly or not at all to healthcare.
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