Wednesday, August 12, 2009

Everything is Rationed

In today's health care debate there is a lot of talk about rationing. If the government takes over they will "ration". The insurance companies are "rationing", deciding what kind of procedures a patient will have. I got news for you, everything is rationed. Not just health care, EVERYTHING! According to rationing is a:
Method for limiting the purchase or usage of an item when the quantity demanded of the item exceeds the quantity available at a specific price.
The key thing to take away from this definition is that the quantity demanded exceeds the quantity available (I'll get to price later). When this condition holds there is no alternative but to invent mechanisms to determine who gets the limited supply of goods. A simple example:
100 people want apples
There are only 50 apples
If this is the situation then one thing is clear, someone won't get as many apples as he wants. For you extra nerdy folks out there, it's the reverse pigeonhole principle (100 pigeonholes, 50 pigeons, some boxes will be empty). There are only two solutions to this problem: One is to increase the number of apples so that everyone who wants one can get one; another is to reduce how many apples are desired (I vote for shooting people).

Let's focus on the demand side since that's where rationing comes into play. Rationing is a general term for the method we choose for determining who gets the 50 apples. We could use their ages, how good looking they are, if they go to church, if they don't go to church, how hungry they are, or any other criteria to determine who gets an apple. When government rations it chooses the criteria and it makes the decisions. Now here's the important point, the free market rations too. The free market causes people to self ration based on price. People who have the money and are willing to pay for an apple, get an apple, otherwise they don't.

Rationing is a result not of the government or the free market but of the real situation. There is excess demand compared to supply. The fact that a price on something exists implies that something is limited in supply. Prices are the free market's mechanism which causes people to self ration. People reduce their demand in proportion with the price. What happens when you don't allow the price to fluctuate? Self rationing is replaced by another kind of rationing. A shortage is a form of rationing known as first come, first serve. Another form of rationing is explicit rationing by the government determining who is deserving and who is not. There are many other variations on this theme.

Rationing in and of itself is neither a good thing or a bad thing. The pricing mechanism of the free market is by far the most efficient mechanism for rationing. We should work within that system, not try to destroy it.


Geoff said...

Spot on! Very clearly articulated.

Geoff said...

Now, let me play Devil's advocate...

1) So, poor people shouldn't get health care?

2) I believe healthcare is a God-given right. A just society owes its citizens (and non-citizens - why not?) any kind of health care they need/want. The costs will just have to be spread across those who pay taxes.

3) The insurance companies should not discriminate against those with pre-existing medical conditions. They should be forced to offer insurance coverage to everyone for the same price.

F. said...

No where do I say that poor people shouldn't get health care. This argument is akin to saying poor people shouldn't get food. The implicit assumption is that rich people would bid up the price of health care and this would make it completely inaccessible to poor people. This would not happen for a bunch of reasons.

First, even rich people are price sensitive. It's not as if rich folks out there form a group and conspire to take all the available health care. Their consumption varies just like everyone else. The same is true in the case of food, no group of rich people buy all the food so no one else can have any.

Second, I didn't mention the second feature of rising prices. Rising prices dampen consumption but they also encourage supply. More health care is provided when there is more money to be made. Health care providers have every incentive to provide services to the poor at a profit just like any other business. Profits foster competition, especially when the marginal cost of providing services to the poor is small.

Finally, if the poor still have too little money to compete effectively in the marketplace we can make them "rich" by giving them money to pay for health care.

To points 2 and 3 I will simply say that sound economics must be considered for all systems. Rights still have to be paid for and saying something is a "right" does not change the economic reality. In fact, pretending like that reality doesn't exist will surely exacerbate the problem.

Anonymous said...

Economic realities are not solidly based on one picture as you have exemplified with the rationing of apples people can get. There are factors to be considered such as the likelihoods of every individual demanding apples. One cannot infer that the demand of apples is bigger than what it is supplied. I think it would open a better picture if you say that you have 100 people, and only 10 demand for apples, 40 demand for pears, and 50 for cherries. The predicament is that you cannot supply the other people because you have 50 apples, 25 pears, and 25 cherries. Then, by "rationing" you would try to balance (fruits' prices being equal) the amount of fruits by supplying less apples and increasing the quantity supplied for pears and cherries. This is a more accurate picture on rationing. Rationing has its efficiencies; it controls the inequalities created in a free market, especially one that has been disrupted, just like today's.

F. said...

Simple question, in your scenario you make the statement that "rationing" would increase the supply of apples and reduce the amount of pears and cherries, how would this happen? How would anyone "know" that people wanted less apples and more of the other stuff?

Anonymous said...

I have never stated that the supply of apples would increase, in fact, I have left it as 50 apples as you have exemplified, however, I did decreased the quantity demanded for apples. Having a singular example is not approachable, we have to take into account all the fruits, since health care carries not only one type of "fruit." There are ways to "know" if people want less or more apples, and everything is an indicative of the needs of the people. Rationing takes place everywhere, in our government, our work, you, me, and even in our free market. Rationing cannot be bound to singular examples such as the apples, otherwise it makes it a restrictive rationing, but if we add other components, there will be true rationing. Health care reform will bring, in the long term, good fruits to eat; I don't think the White House are ignorant to disregard the economic status, but by taking bold steps, we can only know. Reading some past history on health care reform in the many countries that provide public health should help us.

F. said...

Once again the question is how do you know the correct amount of each fruit? You state:

"There are ways to "know" if people want less or more apples, and everything is an indicative of the needs of the people."

Explain a mechanism one can use to get this information.

Anonymous said...

I hope we are thinking of the same fruits, Mr. Freund. I suppose that your example of apples was an analogy to patients demanding a type of treatment, which I believe it would be obvious to know how many patients need such treatments once they have the opportunity to show the need that they have. How would you, then, know that there are 50 apples and 100 people demanding for apples? I would ask you the same question based on how you word things. Please, excuse me if I have misused the word "know," but I solely used it to exemplify, otherwise, neither would you have been able to give the analogy to apples and their demand. Let me fix my wording, "let's suppose we know." Mr. Freund, do not take my words as offense; I am really thankful that at least, people like us can have good conversations than the many stupid ones that roam around on the web (no pun intended).

F. said...

Apples are just an example of a desired commodity or a service. Health care is another type of service.

It isn't obvious to know how many patients need treatments because that is variable. Let's say it costs you nothing to go to the doctor and you have a minor cold but would like it checked out, would you go? Let's say it now costs you a lot of money to go see the doctor for the same minor cold, would you go now? This is an example of how pricing affects demand so it is absurd to say that the demand for something is fixed.

Without a price (in the example I cited for a cold, but the same goes for apples) how would you determine the demand? If apples are free then I presume more people would want them than if they each cost a million bucks.

Your statement "let's suppose we know" is a huge supposition that needs to be answered if we are to make progress in our conversation.

Hopefully my point is clear, if not feel free to ask.

Anonymous said...

I understand your point, but, once again, what you have exemplified is as much of a supposition as well; saying that having "50 apples" and "100 people" demanding for it is a supposition, and I think it would perfectly fit with the notion of "let's suppose we know" that x apples are supplied and x people demand for them.

Now, the reason I oppose to the basic rules of supply and demand in health care is because the rules do not perfectly fit together with the apples. Prices may determine in most cases the demand, but in health care, the prices haven't really set the demand. You see, today's health care prices are too expensive, and do you think people who provide it are not aware of the supply and demand? I think they are, but they also know that health demand will always exist - it doesn't go away by setting prices too high or it doesn't make it any more demanding by setting low prices - no matter at what prices. This is why health is quite stable business. If you are injured (minor or not), you will demand for health care, but if it is too expensive, you wouldn't choose to have it, and many people choose not to have it today. But are companies going to make it any cheaper to match the demand? I doubt it, this is why we need reform. Health is costly, indeed, but everything gets costly once something is in a broken system or better say, broken free market.

F. said...

You confuse cause and effect.
"Prices may determine in most cases the demand, but in health care, the prices haven't really set the demand."

Prices are a reflection of demand, not the cause of it.

The question I have asked twice and now a third time is:
How do determine the demand without a price?

Additionally, you state:
"today's health care prices are too expensive"
Please tell me what the proper price ought to be and how you would figure that out?

Anonymous said...

You say it is a reflection, but I don't see you supporting any evidence that supports it. The only reflection I see from those prices, is the many ignored, ill, people in our country.

Now, regarding to your consistent question, I do not know exactly what the prices should be, however, I know that hospitals have been abusing their patients' money and their insurance companies - this is why many insurance companies agree with a health care reform - by taking the same high rates when less could have been charged. That should give you an idea that overcharging raises the prices, decreasing the willingness to pay for health care; this does not mean it decreases the demand. A sick person will always need care and the healthy one will never worry until misfortune happens. But this is only one example of the many other ways costs can be reduced in order to yield lower prices.

And if I am not wrong, you have previously stated, "Pricing affects demand..." and in another instance, "Without a price would you determine the demand?" I don't see any reflections, and I don't see why you think I am confused when I perfectly followed your wordings.

What do you think the prices should be, Mr. Freund?

F. said...

Prices serve two purposes. The first is signals telling people the real underlying situation (i.e. how many apples there are and how many apples people want). If the price goes up that implies one of two things, people either want more apples or there are less apples available, the price alone can't tell you which, just that the underlying condition changed in some way. Now when prices adjust to reflect the underlying situation people's behavior changes in response to that. Prices cause some to say, "hey I don't want an apple for a million so I'll defer" and it also says to some people, "hey, apples are selling for a million, I'll start selling apples". So, yes in a way prices affect demand but I hope it is clear that prices will only work correctly when they reflect reality. What would happen when they don't? Remember that reality can't be changed. There are only so many apples and people want them. I don't know how many people but I do know that the current price reflects price where everyone willing to pay for an apple is able to get an apple. That is a form of self rationing engaged by the free market. Suppose reality doesn't change but the prices are changed to below the current price. What's the situation now? Some people who had previously decided that the price was too high for apples will buy apples and all those who were willing to pay the higher price will buy apples. But that can't happen, there are the same amount of apples. Some people who are willing to pay for an apple cannot get one. This is another form of rationing, first come first serve. The point being that in all cases the reality is that more apples are demanded than can be supplied. If there were enough apples for everyone this wouldn't be a problem.

I don't know what prices should be, the free market through voluntary exchange discovers what prices are. In effect, it discovers the real underlying situation.

Now, unless you think there is an unlimited amount of health care out there then you have to acknoledge that the demand for health care exceeds the supply. Rationing will occur in the free market and in ANY other system. The only way this doesn't happen is if the underlying situation changes.

Let's assume that you are correct, "A sick person will always need care". They may need it, and I sympathize with that hypothetical person, but if there is nobody to provide it they won't get it. No one can change that. Not even government.

Now there are ideas which can improve the situation and I am more than open to them. What I am saying is absolutely true and anyone who tries to sell you a bill of goods counter to this is either uninformed or disingenuous.

This will be my last post on this topic because I would like to write posts on other topics :) Feel free to comment on those, I really appreciate your comments. If you would like to learn more about basic economics I suggest you read, "Basic Economics" by Thomas Sowell. It's a great book and I highly recommend it.

Anonymous said...

Thank you so much for the elucidation. I am no expert on any economic subject neither am I in the position in trying to correct your statements.
I would like to make a request though, do you mind sharing what is your ultimate view on how the government should approach health care? Because we know that it is badly needed, but economically unsound. But really, thank you for the recommendation! And surely will be pleased to read your other posts - hopefully some will be on food.

If you have more information on any topics, please do inform me.

By the way, I'm just a student going into his sophomore year, trying to learn slowly about this cruel world hah.

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