The challenge for those who wish to expand the use of market incentives in health care is to design policies that align material incentives facing consumers and providers of health care so that changes in behavior enhance economic efficiency. The report provides an overview of efforts to expand the use of market or market-like institutions in health care and considers effects of these initiatives or proposals on the federal budget. Health Care Costs and Public Spending

Health care costs take up a large and growing part of the economy and of public budgets. The pace of health care costs and the expanding public role in health care have stoked interest in using market incentives to slow or limit costs and to improve quality of outcomes. Market Failure and Health Care

Economists' belief in the efficiency of markets is based on the Invisible Hand Theorem, which states that market outcomes are efficient, so long as certain conditions hold. An externality, or spillover effect, exists when one's consumption or production affects the ability of another to consume or produce. No one has an informational advantage over others. No market power . The Invisible Hand theorem takes the distribution of buying power as given. Informational Advantages and Market Failure

The lack of symmetric information, which occurs when some have informational advantages over others, is the source of many of the key problems in health care. The Federal Budget and Market-Oriented Health Care Reform

The rapid rise in health care costs is straining public budgets at all levels of government, and projected increases in health care costs promise to intensify pressures on public budgets. Even if health care costs moderate, a substantial portion of the gains from economic growth will be directed towards the health care system. In part, this is a consequence of their cost structure. Information asymmetries between patients and physicians as well as between providers and payers stem from the unavoidable need for highly specialized roles.
Health care spending is one of the most rapidly growing portions of the federal budget. Projections suggest if the rapid growth in health care costs is not curtailed, governments at all levels will face an uncomfortable choice between significant cuts in other spending priorities or major tax increases. This report examines the economic justification for government intervention and involvement in health care markets.
Many analysts claim market-oriented policies, in certain instances, could lower costs and enhance efficiency in health care. This report discusses the Invisible Hand Theorem, which states that when certain assumptions hold, market outcomes will be efficient. These assumptions require that no one has an informational advantage over another, that no spillover effects exist in consumption or production, that no one exerts market power, and that no scale economies exist in production.
Many characteristics of health care markets fail to satisfy the assumptions of the Invisible Hand Theorem. Moreover, fundamental characteristics of health care (such as informational asymmetries between patients and health care professionals and between payers and providers, as well as ethical and distributional concerns) complicate efforts to expand the use of market or market-like incentives in health care.
Rising health care costs in part reflect the cost of technological advances, whose benefits exceed their costs, and the aging of the U.S. population. The growing role of third-party reimbursement over the past half century weakened incentives to minimize costs and thus has also led to higher health care costs. Many analysts have called for initiatives which would improve the functioning of health care markets, such as improving consumer information and allowing greater use of bargaining. These initiatives may help reduce or slow the growth of health care costs, but may also have unintended negative consequences. Greater use of market-like incentives can improve the efficiency of the health care system, but only if they take into account the special characteristics of health care.