uncertainty and the welfare economics of medical care kenneth arrow l.
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Uncertainty and the welfare economics of medical care Kenneth Arrow. HSPM J712. Arrow laid out in mathematical terms the necessary prerequisites for a free market to have optimal outcomes. why health care doesn't fit the free market ideal. Number 1 reason:

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Arrow laid out in mathematical terms the necessary prerequisites for a free market to have optimal outcomes

why health care doesn t fit the free market ideal
why health care doesn't fit the free market ideal

Number 1 reason:

  • The patient can't evaluate the quality of the doctor’s advice. 
  • Arrow calls this "uncertainty." 
what economists mean by optimal
What economists mean by “optimal”

The Pareto criterion:

  • an allocation of resources is "optimal" if there is no way to rearrange the resources and make somebody better off without making somebody else worse off
  • “Optimal” = “Efficient” in econ jargon
the first optimality theorem
The First Optimality Theorem

If and only if we have:

  • Consumer sovereignty
  • Perfect competition
  • Everything is for sale

Then

  • a free market will generate an optimal allocation of resources
consumer sovereignty
Consumer sovereignty
  • Consumers have the
    • Knowledge
    • Ability
  • To make buying decisions
consumer sovereignty7
Consumer sovereignty
  • When you buy, you know what the product will do for you and what all possible alternative products will do for you
  • You know the price of what you are buying and you know the prices of all alternative products
perfect competition
Perfect competition
  • Buyers and sellers freely choose whether to buy or sell.
    • They freely agree on what price is paid.
    • No government restrictions.
    • Each actor is a small part of the market. Each acts as if his or her decisions have no effect on anyone else.
      • No collusion among buyers or sellers, in other words
      • Why he assumes “no increasing returns in production”
everything is for sale
Everything is for sale
  • “marketability of all goods and services relevant to costs and utilities”
  • No external costs or benefits
  • You can buy insurance against any risk (more on this later)
the first optimality theorem11
The First Optimality Theorem

If and only if we have:

  • Consumer sovereignty
  • Perfect competition

Then

  • a free market will generate an optimal allocation of resources
second optimality theorem
Second optimality theorem
    • Based on the same assumptions
  • If we as a society don’t like the allocation of resources, we can fix it by redistributing wealth
the problem of buying information
The problem of buying information
  • Much of what we buy from physicians is advice.
  • To evaluate the advice – to decide how much it would be worth to us and how much to offer to pay – we would need to know what the advice were.
  • If we knew what the advice were, we would not have to buy it.
buying information is a problem for consumer sovereignty
Buying information is a problem for consumer sovereignty

But this problem is especially bad for medicine, because it’s hard to evaluate the advice even after you get it:

  • You (the patient) don’t have medical training
  • You may be emotionally upset
  • You may be unconscious

Yet you have additional buying decisions to make.