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The Problem With Having a Brain Conditioned by Modern Economic Theory

September 26th, 2010 · 2 Comments · Economics

I’m in the middle of a health care debate with my buddy Steve who for years has been unabashedly advocating the migration of the U.S. economy to a Nordic model social welfare state. Steve is no slouch on the subject, he munches the numbers — but in my mind we have a core disconnect. My brain is wired with a certain set of well established and accepted postulates that are germane to these conversations, but are proving to be alien at best and dismissed at worst.

It’s not unlike the many other resource-allocation debates I frequently have with many of my more progressive friends who have not been brainwashed by years of poring over charts and graphs that model things like supply and demand and how they interact (and are affected by policies and government action.) The conclusions of these models and the case studies connected with them are burned into my ROMS.

Because others lank this indoctrination,  It frequently forces me into situations where the most basic of maxims that economists at large take as given become just another questionable proposition to be debated and proven (or not, if an isolated data point or obscure/wacky research paper seems to refute it.)

At times it makes me feel like the guy with the mechanical engineering degree that in 2007 had to continually “prove” to the assembled wordsmiths at various wine tastings that since alcohol burns at a far lower temperature than gasoline, the utopian dreams of cars powered by corn was, well, nutty. Or that the 100 MPG carburetor is a pipe dream. They didn’t want to hear it, and preferred to not to believe the reality. (Check out the five-year stock chart…)

This is why at times I find myself being forced to debate at length assertions like (I’m not kidding) that Demand curves generally slope downward. Sigh. Based on this research, I am guessing I am not alone.

Many of the propositions put forth by those who are eager to make the world a better place involve what economists call “price ceilings.” Advocates think of it as being more akin to “price justice” because — you know — hey stuff costs too much. Especially for those who are having a tough time making ends meet. And if it comes to things that are rights, like food, water, shelter, health care, travel, vacation, etc. It’s critical that those people who are holding back on providing these goods to the needy are coerced into handing it over.

The logic is flawless, if stuff costs too much, mandate a lower cost, right? Who can argue with that? Hey if Brazil was able to “get off oil” and switch to sugar cane, why can’t we just have the government tell doctors how much to charge?

The problem is that as soon as an economist hears the words “price ceiling”, alarm bells go off in their heads. They know how the story will end, and they know why. From rent controlled apartments to gas price controls, the result is a scenario where the needy get (far) less, providers leave the market and since (as one of my professors used to say) “you can’t legislate away competition” bizarre distortions result.

A basic graphical depiction of what happens to amount supplied is here:


From the textbook Introduction to Economic Analysis by J. Stanley Johnson. Johnson is a Professor of Business, Economics & Management at the California Institute of Technology. Please see page 202 for more info.

The vertical axis indicates price and horizontal indicates quantity. The more something costs, the less it is demanded (D) the more money to be made from a good, the more will be supplied (S). Where S and D (Supply and Demand) intersect is equilibrium and the market price. Too high? Fine, just mandate the horizontal line. Problem solved! Oh wait, qd becomes qs because firms don’t want to supply the right amount at that price! Can’t we just force them? Not really? Shoot. As Paul Krugman puts it, “In many cases, rent control appears to be the most efficient technique presently known to destroy a city except for bombing.”

I say price controls on medical care at a national level are having a similarly destructive effect. To that end I advocated ending Medicare and Medicaid as we know it and proposed moving to a market allocation where the poor would get credits as we do with food stamps. Steve’s response was that I should prove my case by finding research that shows vouchers work better(?!) My initial response is “nonsense.” To anyone who has seriously studied price ceilings and their toxic effects the burden of proof should be on the person who advocates imposing/perpetuating them.

(Full disclosure – Krugman is a fan of Medicare especially as to how he feels they keep administrative costs low, but I have not seen him specifically address the toxic aspect of reduced supply.)

Steve makes the case that hey, Medicare is not inefficient — after all, they do a great job of reporting. My response is that Economics is the study of the allocation of goods and services, not how well reports are generated. If someone can prove how arbitrary Medicare price ceilings don’t result in less care, not only will the argument be won, but they might have a doctoral thesis there.

In the interim, I’ll stick with what most economists (including Krugman) agree with. Price ceilings = bad.


2 responses so far ↓

  • 1 Michael Ejercito // Dec 16, 2010 at 12:04 am

    When price controls keep prices on food, gas, or housing from rising, people tend to demand more.

    By contrast, if price controls keep the price of chemotherapy from rising, people do not demand more chemotherapy, because they do not get cancer more often.

  • 2 Steve Broback // Dec 16, 2010 at 6:31 pm

    Nice try, not even close. Just because a demand curve slopes more steeply (can you say “inelastic”?) doesn’t mean it doesn’t slope at all.

    Despite the vast literature showing that things like chemo do not have an elasticity of zero, I personally know people who have turned down chemo because of the cost.

    Yes, I know, it’s more humane to have people die waiting for treatment than to price it at market rates, but the fact remains, and this is critical: **Fewer people will get chemo if you put a price ceiling on it.**

    There needs to be an incentive for people to provide chemo, and sorry — getting paid is a pretty good incentive. Cutting pricing off at the knees may make activists feel good about themselves, but it kills people.

    More will be told “yes you qualify for free chemo.” They’ll just die waiting.

    …And that’s why Econ 101 should be mandatory before you can register to vote.

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