Markets and Health Care

A long time reader directs me to Paul Krugman's column from last Sunday, where he argues that markets for health care are unlikely to work as well as, say, markets for bread or soybeans or Hyundais or even --- yes --- the iPhone.

Krugman's column very much reflects the consensus view of economists (including this one) on health care. Economists have learned a lot about when markets work and when they don't. Markets work well when there are many buyers and sellers, when the buyers and sellers all know exactly what's being transacted, and when it's possible to get the incentives right.

Health care is the perfect storm when it comes to free-market economics. There's the potential for market power and monopoly, there are big problems with asymmetric information, and the fact that everyone's insured means that buyers don't have a strong incentive to carefully weigh cost vs. benefit.

I've written about problems in health care markets before (actually a lot: here, here, here, and here). But this point bears repeating, given the current debate. The consensus of economists is that "trust the market to allocate health care" will not work very well. As Krugman points out, this doesn't mean that the only solution is single-payer, but it does mean that this is probably a setting where government will play a role.

And lest you think think that this is only some liberal, lefty, New-York-Times view, here's a link to a 2006 column from the Wall Street Journal's economics columnist David Wessel, which essentially makes exactly the same point. (Scroll down a few pages to see it.)

How to Make Money Writing an Economics Blog

As I wrote a while ago, I signed up for Google Adsense, and they manage the ads you see on the page. (Proceeds to the Utah Food Bank.)

Adsense pays you based on some function of page views and clicks, and this blog makes a few cents a day, on average. Adsense doesn't send you a check until you accrue $10, and I figured it would take years to hit that hurdle.

But then the new iPhones came out.

I was doing some game theory with the EMBAs at the time, and so I wrote a short blog item describing the developer/user coordination game. The post is nothing terribly deep or insightful; just the basic economics of platform competition.

I think the blog traffic on that one post was bigger than the traffic for all my other posts combined. This blog was making about 50 cents a month, on average, from ads. In June, I made more than $6, and that pushed me up over the $10 mark. I'll be sending some funds to the UFB as soon I get a check from Google.

I'm not saying this to try to boast about how insightful I am. As I said, the iPhone blog post is basic network economics that I learned from Garth Saloner (recently appointed as Stanford GSB dean) way back in 1991.

Rather, I'm saying it to point out how interested people are in the iPhone.

I have an iPhone and I like it, but I don't really see where the fascination is coming from.

The strategy and economics of the iPhone are a bit more interesting than, say, the economics of soybeans. But there are lots of goods and services with interesting economics. I think, for example, that the economics of higher ed are richer, more interesting, and more important than the economics of the iPhone.

But I should just be happy that there is something that draws interest to economics blogs. Probably business professors should drop all examples that don't involve iPhones --- we'd do a better job of holding our students' interest!

Just as an experiment, I'm going to put the word "iPhone" in each of my next three posts, just to see what that does to traffic. I promise to report back.

Hyundai

A while back I prattled on about the economics of asymmetric information. I wrote about how asymmetric information might affect the market for used cars. And about how the World Series of Poker is a great illustration of how to infer, based on someone's actions, what their information must be.

And here's a great NPR story combining the two ideas.

Hyundai, the Korean carmaker, had big quality problems in the late 1980s. Throughout the 1990s, the firm invested heavily in figuring out how to make better cars, and by 1998 Hyundai's cars were plums, not lemons. But perceptions are hard to change. A consumer won't pay a plum price for a car that he or she believes to be a lemon, even if the seller knows that it's a plum.

Hyundai had to figure out how to credibly communicate the "We are selling plums" message.

They did it with an aggressive warranty program. How does that work? Suppose you are a firm and you know that you haven't solved all of your quality problems. Offering a 100,000 mile warranty would be suicide --- because your cars will break down and you'll have massive repair bills. Even if offering the warranty allows your firm to fool consumers into paying plum prices, the time bomb of looming warranty obligations will kill you.

But if you know that you have solved your quality problems, then the warranty offer won't be as costly down the road.

Important point: A warranty program is prohibitively costly for a firm selling lemons. It's not prohibitively costly for a firm selling plums.

This means that only a plum-seller will be willing to offer it.

And this means that consumers --- seeing an aggressive warranty --- will infer that quality problems have been solved, because only a plum seller would be willing to make an aggressive warranty offer. The warranty is therefore a credible signal of product quality.

To tie this back to the earlier poker discussion, Hyundai had to figure out what action it could take that would cause consumers to infer that Hyundai cars were plums. It had to find some action that made economic sense for a plum seller, but didn't make economic sense for lemon seller. And the warranty is just the ticket.

The NPR story describes this as a "marketing move," which it is. But to understand why it's so smart, you need to understand information economics. And this illustrates why economic reasoning is useful across all functions of management.