SQU Med J, August 2011, Vol. 11, Iss. 3, pp. 328-337, Epub. 15th Aug 11
Invited Article
Submitted 12th Nov 10
Revision ReQ. 10th Apr 11, Revision recd. 10th May 11
Accepted 24th May 11

A common argument heard in health care planning and health policy reform debates is that the government should 
stay out of health care and let the market allocate 
resources efficiently. It is further argued that 
government rules and regulations applied in 
health care markets interfere with proper resource 
allocation resulting in inefficiency.1 The argument 
further states that without government interference, 
the "invisible hand" of the market would allocate 
resources optimally leading to economic efficiency 
in health care.

Although interesting, this argument is based 
on the assumption that health care meets all 
necessary conditions for an ideal perfect/free 
market. Unfortunately, this assumption is never 
articulated explicitly therefore the argument is 
not fully explored, understood or challenged. It 
is important to explore fully the argument, the 
assumptions made about the free market, and the 

conditions necessary for the "invisible hand" to 
allocate resources efficiently.2

A market that meets all necessary conditions for 
efficient resource allocation is an ideal in economic 
theory, but a rarity in the real world. Markets do 
fail because necessary conditions for perfect/free 
markets are rarely met in any industry and least of 
all in health care.3 When the necessary conditions 
of the ideal free market are not met, there can 
be market failures some of which are not easily 
corrected by the market and therefore require 
interventions from outside the market. 

Another important issue that is also rarely 
articulated is whether free markets are a desirable 
feature of a health care system. This issue cannot 
be easily addressed through economic theory. It is 
an issue that requires a closer examination of the 
philosophy behind the foundation of the health care 
system in any country. It requires an examination of 
the culture and beliefs of the country about health 

1University of Oklahoma Health Sciences Center, Okalhoma City, USA; 2College of Public Health, University of Oklahoma Health 
Sciences Center, Okalhoma City, USA.
*Corresponding Author email: ala@ou.edu

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aBstract: A common argument in the health policy debate is that market forces allocate resources efficiently 
in health care, and that government intervention distorts such allocation. Rarely do those making such claims 
state explicitly that the market they refer to is an ideal in economic theory which can only exist under very strict 
conditions. This paper explores the strict conditions necessary for that ideal market in the context of health care 
as a means of examining the claim that market forces do allocate resources efficiently in health care. 

Keywords: Health economics; Ideal market; Market structure; Market failure; Perfect competition; Market forces; 
Supply/demand; Equity; Economic efficiency

REVIEW

Health Care Market Deviations from the Ideal 
Market

Ari Mwachofi1 and *Assaf F. Al-Assaf2



Ari Mwachofi and Assaf F. Al-Assaf

review | 329

and health care. Is health care a commodity to be 
bought and sold for profit, or is it a basic human 
right that should be accessible to all citizens? 

s o m e b a s i c e c o n o m i c s c o n c e p t s 
a n d d e f i n i t i o n s
For the sake of clarity and simplicity, it is necessary 
to define some basic economic terms and concepts. 
Efficiency is central to economic theory because 
human beings have unlimited wants but limited 
resources with which to meet those wants. Given 
the limited resources, human beings constantly 
make decisions that require tradeoffs. For example, 
a working person earning $200 per week has many 
wants that might require more than the earnings. 
Because of the limited earnings, the individual has 
to prioritise in order to meet the most important 
wants, or the wants that provide the highest level 
of satisfaction. For each want met, there are several 
unmet wants (the trade-offs). The term efficiency 
means that resources are being used where they 
provide the highest value. Efficiency in consumption 
means that consumers use resources where they get 
the highest satisfaction level. For producers of goods 
and services, being efficient means they produce at 
the lowest possible average cost. 

The term market refers to a situation where 
buyers (consumers) and sellers (producers) interact 
(directly or through intermediaries) to trade goods 
and services. It is a situation where forces of 
demand and supply interact to determine prices of 
goods and services being exchanged. Therefore, a 
market includes mechanism for: determining prices 
and quantities of the traded item, communicating 
information about prices, and for the distribution of 
the goods and services. Supply is the total amount of 
a product (good or service) that producers (sellers) 
are willing and able to sell at a specified price. 
Demand is the total amount of a good or service 
that consumers are willing and able to purchase at 
a given price. Market forces of supply and demand 
represent the aggregate influence of self-interested 
buyers and sellers on prices and quantities of goods 
and services offered in a market. Demand arises 
from consumers' push to get as much satisfaction 
as possible (utility maximisation) given their 
income limits, so it is a reflection of the value that 
consumers associate with the goods or services. 
Supply arises from producers’ effort to maximise 
their profits. It reflects the costs of production. 

Driven by self-interest, consumers will try to pay the 
lowest prices possible while producers try to sell at 
the highest price possible. This process results in an 
equilibrium where the quantity demanded is equal 
to quantity supplied at which point the equilibrium 
price and equilibrium quantity are determined.4

Under ideal conditions, production of goods or 
services is efficient (meaning that it is done at the 
lowest possible per unit cost). Consumption is also 
efficient—meaning that consumers are getting the 
best value for their money by combining goods and 
services in a manner that attains them the highest 
possible satisfaction (maximum utility) given their 
limited income. In other words, there is no waste in 
production or in consumption. This is the condition 
is described by economists as Pareto optimality or 
social efficiency. Under Pareto optimality everyone 
is at their highest possible welfare level given the 
resources they own. This occurs automatically 
only under ideal market conditions that facilitate 
the "invisible hand's" efficient resource allocation.2 

However, in the real world, ideal market conditions 
are rarely met. Consequently, there are market 
failures, meaning that the market fails to allocate 
resources efficiently, there is waste in production 
(average production cost is not at its lowest level), 
or in consumption (individual consumers are not 
attaining the value for their money), and Pareto 
optimality is not attained which means that there 
is resource waste and social welfare is less than 
optimal.3

h e a lt h c a r e m a r k e t s 
Health care has several interdependent markets 
such as: education, manpower, institutional, 
pharmaceutical and others. The education market 
determines how many doctors, nurses and other 
professionals are trained every year and therefore 
how many such professionals are available to provide 
services. In this market, prices can be viewed in 
terms of tuition and other costs to the individual 
seeking training to be a physician, a nurse or other 
professional. Manpower markets determine labour 
prices (salaries and wages) paid to professionals. 
Institutional markets determine prices for 
hospital stays, or stays in nursing homes. In the 
pharmaceutical markets, prices of medications are 
determined. One can identify many other markets 
in health care. Because of the nature of the product 
for sale and the structure of health care markets 



Health Care Market Deviations from the Ideal Market

330 | SQU Medical Journal, August 2011, Volume 11, Issue 3

power in the market.  

The ideal economic structure is perfect 
competition which has the following characteristics: 
many sellers (firms) and many buyers and each one 
individually too small to affect price levels so they 
are all price-takers not price-setters; homogeneous 
products such that buyers are unable to discern 
any difference between products sold by different 
sellers/firms; firms can enter and exit the market 
freely without restriction from regulations or 
costs so that new suppliers can enter the market 
to increase competition, or be forced to leave the 
market if they are inefficient; perfect knowledge/
information about prices, and technology so that 
consumers and firms can access such information 
at zero cost, and no externalities (spill-over effects, 
e.g. smoking affects non-smokers) in production 
and consumption. These characteristics define 
an ideal market structure that might not exist in 
its pure form in real life, but has normative value 
and provides an understanding of how equilibrium 
prices and quantities are determined by market 
forces.

Economists can demonstrate mathematically 
(First Fundamental Theorem of Welfare Economics)3 
that perfect competition leads to Pareto optimality. 
Consumers get the "best bang for their buck" and 
producers produce at the lowest per unit cost. 
Inefficient producers are weeded out (go out of 
business because they make heavy losses) so that 
only the efficient producers survive, i.e. survival of 
the efficient. If the conditions of this market are not 
met, the market is unable to attain efficiency. For 
example, if there are barriers to entry or exit, new 
producers cannot get into the industry to increase 
competition. Prices and costs of production remain 
high and inefficient producers stay in business 
because they are protected from having to compete 
with more efficient producers. With higher prices, 
consumers do not get the best value for their 
money. There is inefficiency in production and in 
consumption. 

Perfect competition attains efficiency because 
producers compete and increase production, 
which lowers the prices that consumers pay. Lower 
prices force producers to be efficient (produce at 
lower average costs) so as to make a profit. Those 
unable to cut their production costs experience 
losses and eventually have to go out of business. 
Inefficient producers have higher average costs and 

most of these markets do not meet the ideal perfect 
market conditions that facilitate efficient resource 
allocation. 

i d e a l m a r k e t c o n d i t i o n s – w i t h 
r e f e r e n c e t o h e a lt h c a r e
Several conditions facilitate the efficient workings of 
the market leading to efficient resource allocation. 
The main set of conditions can be viewed in terms 
of market structure. Other conditions include: 
marketability of all goods and services; demand 
certainty, i.e. The demand that is regular and 
predictable; supply certainty, i.e. the known or 
predictable quality of the product; avoidable risks; 
the customer's ability to test the product before 
consumption; information symmetry (between 
buyers and sellers); no price discrimination 
(charging consumers different prices for the same 
product), and that all suppliers in the market have 
a profit motive.5 Other implied conditions are: 
consumers have sufficient information to make 
good choices; consumers can accurately predict the 
results of their consumption decisions; individuals 
are rational; a person is the best judge of his/her 
own welfare; there are no externalities; consumer 
tastes are predetermined; supply and demand are 
independently predetermined; firms do not have 
monopoly power; there are no increasing returns to 
scale, and others.6 We will examine some of these 
conditions in the context of health care:

m a r k e t s t r u c t u r e
The structure of the market in which the firm is 
operating has a significant effect on efficiency.  
Market structure is defined by: the number and 
size of the firms in the market; the ease with which 
firms may enter and exit the market; the degree to 
which firms' products are differentiated; and the 
information available to both buyers and sellers 
regarding prices and product characteristics. Market 
structure characteristics determine competition 
which ranges from perfect competition where 
there are many small sellers and many buyers, a 
homogenous product and everyone is a price-taker, 
to a pure monopoly where there is only one supplier 
or a monopsony, a market with only one buyer. 
Between these extremes there are other structures 
such as monopolistic competition (many buyers 
and many sellers with a differentiated product) 
and oligopoly with a few sellers varying in size and 



Ari Mwachofi and Assaf F. Al-Assaf

review | 331

therefore they incur heavy losses and are forced to 
shut down production. Only efficient producers 
survive in the market—survival of the efficient 
again. Thus, perfect competition automatically 
weeds out inefficiency and improves consumer 
welfare through lower prices. Lower prices enhance 
consumers’ purchasing power so that they are able 
to meet more wants with their limited resources/
income, thus gaining more "value for their money".7

The structure of markets in health care is not 
competitive. There are barriers to entry and exit. 
Some barriers come from professional licensing,  
long and expensive training and expensive  
investment requirements (e.g. hospitals are 
expensive to build). The barriers might protect 
inefficient producers from being weeded out so 
that efficient resource allocation does not occur 
automatically. There might be a few hospitals in 
a city (oligopoly) or only one hospital in a rural 
location (monopoly) and a drug company with a 
patent is a monopoly with the power to set prices. 
Other conditions of perfect competition are 
contravened in health care: product homogeneity—
the services of one physician are not identical to 
those of another; rather than perfect information, 
there is information asymmetry which can be a 
serious source of market failures as demonstrated 
later (see information asymmetry below). Price 
discrimination is common in health care (consumers 
pay different prices for the same service depending 
on their incomes or bargaining power). Obviously, 
health care markets do not meet the conditions of 
perfect competition. In health care, there are firms 
that have market power and are able to move and 
set prices. For example, a rural community that 
has only one hospital is essentially a monopoly 
within that geographic area. Such a hospital is 
not facing serious competition so it will be able to 
set prices high enough to suit its revenue needs. 
More importantly, it does not have to be efficient 
in production because it is not necessarily going 
to be driven out of the market by more efficient 
producers. Another example is a pharmaceutical 
company that has a patent on a drug. The company 
is a monopoly by virtue of the fact that no other 
company can legally produce and sell that drug 
until the patent runs out. For the duration of the 
patent the drug company is a monopolist. It is a 
price-setter for that particular drug, it can earn 
high profits and it will not have to be efficient in 

production because it is not facing any competition. 
Because of the structure of health care markets, 
producers are not forced to be efficient. The market 
does not punish inefficiency as would be the case 
under perfect competition. 

There are other market structures that lead to 
sub-optimal resource allocation because some 
agents have enough power to set prices by shifting 
demand or supply. For example, if there are only a 
few large sellers in the market (oligopoly) the sellers 
have enough market power to set prices and the 
market fails to allocate resources efficiently. A good 
example of oligopolies is in the US health insurance 
industry which is dominated by a few large 
companies. In some local areas, there might be only 
one company which essentially means that they are 
monopolies. Thus the condition that everyone in 
the market is a price taker is contravened in health 
care and that does lead to market failures.

p r o d u c t m a r k e ta b i l i t y
Health care as a product or service is not consumed 
because it provides a consumer with satisfaction 
(it might even be unpleasant or painful), but 
because the individual wants to retain good health. 
The demand for health care is derived from an 
individual’s wish to regain good health. The qualities 
of the product (health) make it difficult for markets 
to meet the ideal market conditions. Health is not a 
marketable product, that is, it cannot be exchanged 
between consumers. Since demand for health care 
is derived from the demand for health, the non-
marketability of health reduces the power of market 
forces (demand and supply) to determine prices and 
quantities. Consequently the ability of the market 
to determine resource allocation is greatly reduced.

i n f o r m at i o n a s y m m e t r y
There are several information asymmetries in 
health care, but we will examine two: between the 
doctor and the patient, and between the consumer 
and the health insurance company. 

Doctors (suppliers) know more about illness 
and treatments than their patients. Patients depend 
on the doctor to act in their best interest, but there 
is a conflict of interest because the doctor is selling a 
service to the patient. The doctor is in a position to 
determine demand for the service (acting on behalf 
of the patient, presumably for the patient's welfare) 
and the doctor is also the supplier of the services. In 



Health Care Market Deviations from the Ideal Market

332 | SQU Medical Journal, August 2011, Volume 11, Issue 3

universal coverage, i.e. everyone buys coverage so 
that insurance companies have a pooled risk which 
on the average is lower than the risk from covering 
only the very ill. The other solution is screening and 
experience rating that allows insurance companies 
to change different premiums according to risk 
levels.13 Studies indicate huge welfare losses due to 
adverse selection.14 

m o r a l h a z a r d 
Individuals covered by insurance tend to use more 
health care and they might not take necessary 
precautions to stay healthy because they know they 
have insurance coverage. This leads to inefficient 
use of resources. Insurance companies try to correct 
this by employing gate-keepers who monitor and 
restrict health care access and by charging co-
payments and deductibles. Unfortunately, these are 
applied to everyone including those not overusing 
services, which make these solutions inefficient.

i n t e r d e p e n d e n t d e m a n d a n d 
s u p p ly d e t e r m i n at i o n
An increase in demand for health care (e.g. due to 
an influx of population, or an epidemic) can lead to 
higher prices for such care. The increase in prices 
might result in the physician supplying less hours 
of work. For example, if a physician wants to earn 
$100,000 per year, he may usually earn that much by 
seeing 100 patients a week. If the price for services 
goes up, he might be able to earn that income by 
seeing only 80 patients a week. He/she will then be 
able to hit the target income by supplying less hours 
of work—thus seeing fewer patients and spending 
more of his/her time on leisure. This situation 
results in the famous "backward bending" labor 
supply curve. Thus supply and demand in health 
care are not determined independently leading to 
market failures.

c o n s u m e r r at i o n a l i t y a n d a b i l i t y 
t o m a k e t h e b e s t j u d g m e n t s 
a b o u t t h e i r w e l fa r e
Consumers seeking care are not always in a position 
to make the best judgment about their welfare even 
if they have the ability and freedom to do so. For 
one, they lack necessary information about their 
illness or the effective treatment. Moreover, there 
are some situations of extreme stress making it 
impossible for the individual consumer to make the 

this case demand and supply are jointly determined 
by the same individual at the same time which can 
result in market failure. For example, if the doctor 
is driven by the profit motive, or is seeking higher 
income, the doctor might order more services 
than necessary (e.g. if he/she owns a laboratory 
or imaging equipment). This market failure is 
termed “supplier induced demand”. There are 
several studies that indicate evidence of supplier-
induced demand in health care. In a Japanese study, 
Izumida, Urushi and Nakinishi found that increases 
in the number of physicians per capita significantly 
increased use of inpatient services and outpatient 
services.8 This implies that when more doctors 
moved into an area they had to share the patients 
so they increased demand for their services in each 
encounter by inducing demand from the patients 
under their care. Another Japanese study examined 
whether more frequent use of percutaneous 
transluminal coronary angioplasty (PTCA) for 
patients with acute myocardial infarction (AMI) 
in Japan is driven by physicians’ self-interest or by 
patient behaviour.9 After controlling for a patient’s 
detailed characteristics, they found that increases 
were significantly related to physician-initiated 
expenditures and the effect is higher for high-tech 
treatments. This finding is supported by findings of 
an American study that found similar market failure 
in large metropolitan areas.10 Similarly a study of 
ambulatory care in France found strong support for 
the existence of physician induced demand in the 
French system.11

Information asymmetry between individuals 
purchasing health insurance and the insurance 
company results in two market failures termed 
adverse selection and moral hazard. 

a d v e r s e s e l e c t i o n
Individuals in poor health have a greater incentive 
to purchase health insurance than those in good 
health. Individuals in poor health make greater 
utilisation of health care than the healthy, leading 
to higher payouts by the insurance company. To 
avoid incurring losses, insurance companies might 
raise premiums. Higher premiums will further 
discourage healthy individuals from purchasing 
health insurance so that only the very ill buy 
insurance leading to losses by insurance companies 
and eventually this might mean the demise of a 
market.12 This market failure can be corrected by 



Ari Mwachofi and Assaf F. Al-Assaf

review | 333

judgment (e.g. someone in a car accident, passed 
out on the roadside). Furthermore, consumers 
cannot accurately predict the results of consuming 
health care. When visiting a doctor for a particular 
condition, the consumer is not able to predict 
accurately what the results of the visit will be, even 
if they have been through similar circumstances 
before. A treatment regimen that worked previously 
might not work the same way. 

Economists consider an individual to be rational 
if they made consistent and transitive decisions.  
"Consistent" means that when faced with the same 
conditions they make the same decisions every 
time. "Transitive" is used in the mathematical logic 
sense that, in a relation between three elements, if it 
holds between the first and second, and it also holds 
between the second and third, it must necessarily 
hold between the first and third. For example, an 
individual is offered three choices A, B, and C. If 
they prefer choice A over B and they also prefer 
choice B over C then they must prefer choice A 
over C. Economists would consider an individual 
rational if they decided/acted in this manner. 
However there are numerous findings of consumers 
acting irrationally.15 This is why we all ask ourselves 
the question “What was I thinking?” after realising 
that we acted irrationally. Thus there is evidence 
that consumers do not always act rationally thus the 
condition is not met in health care.  

e x t e r n a l i t i e s

Externalities are spill-over effects of consumption 
or production. Positive externalities occur when 
the actions of one individual result in a spill-over 
that improves the well being of another individual 
and negative externalities impose a cost on another 
individual. Smoking is an example of a negative 
consumption externality because one individual's 
consumption (smoking) affects other people's health 
negatively (effects of second-hand smoke). An 
example of a positive externality is immunisation. 
If some individuals are immunised they provide 
"herd immunity" in the sense that they do not get 
the illness therefore they do not pass it on to others. 
Their immunisation provides a benefit to others—a 
positive externality. 

With the presence of externalities, individual 
production or consumption decisions are not  
optimal because they are made without 
consideration of all costs or benefits. Often, spill-

over effects are not included in decision-making 
because they are not visible to the producer or 
consumer. In the case of a negative externality, the 
external spill-over costs are not included and in the 
case of positive externality, the spill-over benefits 
are excluded. Therefore, the consumption or 
production level selected is not optimal or efficient. 
In cases of positive externality, the production 
or consumption level is below the optimal while 
with negative externalities the level is higher than 
optimal. Therefore externalities lead to inefficiency 
and so to market failures. 

The market is usually not able to correct 
inefficiencies arising from externalities. To correct 
failure due to externalities, the consumer or 
producer has to consider both the private and 
the external (spill-over) costs or benefits. Such 
considerations in the decision-making process 
would result in production or consumption at 
optimal levels. One method of making the producer 
or consumer consider total benefits or costs in 
production is to provide subsidies in case of positive 
externalities, or taxes in the situation of negative 
externality. The subsidy makes the external benefit 
part of the private benefits that the consumer 
or producer will consider in decision-making so 
as to arrive at optimal production/consumption 
quantities. The tax serves to make the producer 
aware of the extra costs that they impose on society 
so that they can arrive at optimal quantities in their 
decision-making. Thus taxes or subsidies might 
eliminate the effects of externalities and lead to 
efficient allocation of resources. However, these 
usually require government action. The way taxes 
are used (allocated and distributed) has an effect 
on societal welfare. Furthermore, there are issues of 
measurement and arriving at the correct amount of 
tax or subsidy that will lead to efficiency.

p r e d e t e r m i n e d c o n s u m e r ta s t e s
Another implied condition is that consumer tastes 
are already determined at the time the consumer 
enters the market. This condition is not met in 
health care and consumer tastes are malleable. For 
example, consumers in the USA might demand 
newer, more expensive technologies rather than 
older ones that are equally effective, but less 
expensive. Such demands lead to unnecessary 
increases in health care costs—an inefficient use of 
resources (market failure).



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334 | SQU Medical Journal, August 2011, Volume 11, Issue 3

profits. Under perfect competition, they are driven 
to be efficient, not only by the profit motive, but 
also by the need to stay in business. In doing so 
they use resources efficiently thus improving social 
welfare; however, in health care not all firms are 
profit driven. For example, in the USA and in other 
countries, there are hospitals that are not for profit, 
but provide a necessary service. In fact, of the 5,162 
hospitals in the USA in 2008, only 1,072 were for 
profit (20.8% of the total). This implies that the 
majority of the hospitals are driven by other goals 
than profit.16

Empirical evidence suggests that doctors might 
be motivated by a "target income"17 not necessarily 
by profit. They might also be motivated by the 
satisfaction they get from seeing their patients 
recover. Thus the profit motive is not always the 
dominating factor in health care. This implies that 
health care firms are not necessarily driven to be 
efficient in production as other firms aiming to 
make a profit under stiff competition.  

In the USA, a large number of nursing homes are 
for profit and so is the health care product market 
(pharmaceuticals and equipment). Therefore the US 
health care industry is not all profit driven but has 
for-profit enclaves. This would imply that the profit 
motive condition is also contravened in health care. 
Firms do not always strive for efficiency.

In the USA, there are disparities in health status 
and access to care. Minority populations (African 
Americans, American Indians, Hispanics and 
others) experience poor health status and poorer 
effective access to health care than the majority 
white population.18 Moreover, there are geographic 
disparities (lower access in rural than in urban 
areas) and socioeconomic disparities with the 
poor having worse health than the rich. There are 
also gender disparities with women experiencing 
worse health care access than men although they 
have longer life expectancies. There is therefore an 
unequal distribution of health and health care that 
is not approved by society. Some of the reasons for 
the unequal distribution are economic while others 
might be historical. The minority health disparities 
seem to be experienced by other countries as 
well such as the UK,19 India, Australia and others. 
Disparities might not be corrected by the market. 

r e t u r n s t o s c a l e 
Increasing returns to scale refer to production 
situations with large fixed costs so that as the scale 
of production increases the average (per unit) cost 
of production decreases. This is true in industries 
that require expensive machinery to operate and, 
once the machinery is in place, the extra costs of 
production are not as high as the initial costs of 
setting up such machinery. In health care, there 
are increasing returns to scale. For example a 
hospital or imaging centre might cost a lot to build 
and equip, but once it is in operation the more 
services it provides the smaller the per unit costs 
of providing each unit of service. The existence of 
economies of scale leads to market power because 
large firms have lower average costs and are able to 
survive in the market and to make profits. This also 
means that the large firms are more efficient than 
the smaller ones. If there are economies of scale, it 
would make sense to ensure that the industry has 
a few larger firms producing at low per unit costs 
rather than many little ones producing at higher per 
unit costs. This might happen naturally (survival 
of the most efficient) because larger producers 
experience lower average costs and are less likely 
to make a loss than small firms producing at high 
average costs. If there are infinite economies of 
scale, the most efficient production might need only 
one firm—a situation termed natural monopoly. 
This situation gives the one or few firms a great deal 
of market power which can be used to set prices 
at very high levels (reducing consumer purchasing 
power and welfare), produce poor quality services, 
or practice price discrimination (segmenting the 
market and charging consumers different prices 
for the same good or service). This situation can 
lead to a transfer of income from consumers to the 
powerful producer, and therefore, a decrease in 
consumer welfare. The bottom line then is that this 
condition (no economies of scale) is contravened 
in health care leading to non-competitive market 
structures and to monopoly pricing and lower 
consumer welfare—market failures.

p r o f i t m o t i v e
According to economic theory, the objective of a 
producer is to make as much profit as possible (profit 
maximisation). Producers who seek to maximise 
profits are forced to be efficient because they need 
to reduce production costs so as to increase their 



Ari Mwachofi and Assaf F. Al-Assaf

review | 335

i n t e r v e n t i o n s t o r e d u c e e f f e c t s 
o f m a r k e t fa i l u r e
Consistent with economic theory, markets respond 
to failures by developing structures that fill the 
gaps resulting from such failures.3 Examples of 
such structures in the US include: independent 
physicians, cost-based reimbursement for hospitals 
and managed care.20 To some degree, health 
insurance is a structure that covers market failure 
due to large unavoidable risks of illness. Market 
structures are not always successful in closing such 
gaps. They might even create other inefficiencies as 
is the case of health insurance (adverse selection, 
moral hazard and stinting)

Governments can and do intervene in markets 
to correct market failure. The intervention might 
come in the form of taxes, subsidies, regulations 
and providing services directly. In US health care 
there are subsidies for older people, or people 
with disabilities and for children. Support for 
direct supply of services is that governments can 
provide more of the merit goods or services with 
positive externalities that markets tend to under-
produce; they can provide services in industries 
with economies of scale and ensure that minimum 
standards are met and there is greater equality 
in distribution of goods or services. However, 
government intervention is not always successful 
in correcting market failure. There are government 
failures due to reasons such as: poor information 
about the type and size of services needed to correct 
the failure; political exigency focusing on short 
term effects (e.g. in an election year) rather the long 
run goals; administrative costs and bureaucracy; 
inefficiency because there are no incentives to be 
efficient; multiplicity of conflicting objectives in 
government, and changes in government policy as a 
result of the political business cycle. 

Discussion and 
Conclusion
Obviously, health care markets do not function 
like the ideal economic market. These markets 
do not meet all necessary or sufficient conditions 
for the ideal economic market. Therefore, there 
are numerous market failures and inefficiencies 
due to such failures. Moreover, the distribution of 
health and health care is not at a desired level. As 
a consequence, there have to be interventions in 

these markets to close gaps and improve efficiency. 
However, issues of economic efficiency, market 
structure, and whether the government has any 
role in the health care of its citizens can be a cause 
of bitter and divisive political debates (e.g. 2010 
US Health policy reforms). Such debates tend to 
use economic theory without full disclosure of 
the assumptions made about the market. This is 
particularly true of arguments that support the 
market economy blindly without due consideration 
for market failures and their impact on economic 
efficiency and social welfare. The result is statements 
that sound true to a non-economist, but are totally 
false given that the wrong assumption has been 
made. 

There is evidence that government control in 
health care can have desirable results in the form 
of better and equitable access to care and good 
health outcomes. Some of the more successful 
health care systems are government controlled with 
little influence from the market and others are very 
tightly regulated. A good example of a government 
controlled health care system is the Cuban system. 
It is built on a strong primary care foundation. 
It provides comprehensive health care to all its 
residents with nobody falling between the cracks.21 
Despite Cuba being a poor country, it attains health 
outcomes that are comparable and sometime better 
than those of rich economies such as the USA. 
For example, Cuba enjoys higher vaccination rates 
(99.9%); an excellent ability to control and quell 
epidemics effectively; high life expectancies (78–84 
years), and low infant mortality rates. Despite being 
under a trade embargo, Cuba has developed a unique 
methods of treating illnesses such as Parkinson's 
disease, retinitis pigmentosa, multiple sclerosis and 
other neurological disorders. It exports medical 
products such as vaccines. Consequently, Cuba 
attracts about 20,000 health tourists annually.22 

Cuba sends doctors to provide services all over 
the world and trains doctors from other countries 
through a programme of international giving and 
support. One fundamental difference between the 
Cuban system and market-based systems is the 
philosophy on which the system is built. 

The philosophical question for any health 
care system is, "Should health care be traded for 
profit?" a question that relates back to an even more 
fundamental question, "Should health be treated as 
a human right or as a commodity that can be traded 



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336 | SQU Medical Journal, August 2011, Volume 11, Issue 3

forces alone. For example, if health and health 
care equity are desirable features, there might be 
need for government intervention because these 
qualities are not easily attained through the market. 
Government involvement in health care is often 
necessary because there are many market failures 
in health care and the market is not always able to 
correct such failures. 

It is even more important for smaller countries 
to determine and explicitly state the philosophical 
foundations of their health care systems. The 
reason for this is that smaller countries might 
have economies that are more open and therefore 
more vulnerable to economic changes than other 
countries/economies. Furthermore, their citizens 
might be dependent on accessing care from other 
countries, or at the very least they might depend 
on getting health care manpower from other 
economies. These conditions might cause the 
small country to "import" inefficiencies from other 
economies that are a result of market failures or 
even government failures. For example in Oman, the 
health care system might use care providers from 
outside the nation. This might make their system 
more vulnerable to inefficiencies from outside 
Oman. However, the example of Cuba indicates 
that a small economy can avoid the inefficiencies 
of other economies by being clear about what the 
fundamental purpose of their health care system 
is and then building it to attain the stated purpose. 
Another example is Thailand that reformed its 
health care system in 2001 with a clear purpose of 
attaining universal health care. With this aim, the 
country built a health care system supported by an 
insurance system and an electronic data storage 
and access system that improved efficiency and 
increased access for the poor.24 

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The fundamental philosophy governing the 
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