Saturday, November 14, 2009

Controlling Costs, “Lowering” Prices, and Naturally High Prices

By Christopher Espinal

It’s unfortunate that in general humans automatically associate a word with one idea or image. Why is that unfortunate? Rhetoricians and those gifted with illustrious and motivating words can abuse those humanly biased language patterns to paint a misleading image of the real world.

One of those misleading concepts is the idea of controlling costs. What do you think of when you hear the idea of controlling costs? You think of a lower price, a lower dollar sign – you think of having more money and more security – you think of living a life that’s a bit easier than before.

However, prices don’t have to be in the form of an invoice or dollar bills. Prices are simply measures of what you have to give up for something you desire. I have to walk a mile to get to class – that mile is a price. In matter of fact, It takes me 30 minutes to walk to class – that’s a price – in a different “currency.” Yet, the concept remains.

What if I had to walk that same mile to get to class but I must do so in 15 minutes? Are you so naïve as to accept the notion that the price of getting to class has been lowered? It may be true if I were given some form of transportation at little cost to me. What if I still had to use my body as transportation? That means I might have to run that mile to get to class – possibly arriving to class drained of energy that I could have used to pay attention.

Of course I wanted to illustrate an example of the final price of getting to class being the same or higher – despite a reduction in price by one type of currency - time. The implicit price of everything is not what it readily seems – for that is implied by the word implicit (clever huh?).

I brought up this concept for a reason: health care. There’s no point in me rewriting everything above to directly address the health care debate. I think you get the general point.

Regardless, what does it mean to lower costs so that life becomes a bit easier and more secure? Well that’s a question that has endless solutions – none of which can be guaranteed from this or any health care proposal.

To lower the cost of healthcare is to lower the costs of its inputs and/or to increase the level of competition. What can help lower the cost of the inputs? Several things can help achieve that goal: an improvement in technology, a sudden increase in the supply of inputs, a greater degree of efficiency in the means of production, etc.

Don’t be fooled into believing that only lowering the costs of inputs and productions will lead to a lower price of healthcare. Competition ultimately lowers the price unless a monopolistic firm can show benevolence to its consumers – a far stretching possibility.

That’s all boring stuff that everyone knows. Let me end this discussion with a provocative question. Do all prices have to be low? Is it always possible to lower prices at the discretion of the government? I wouldn’t say so.

Sometimes markets are bound to become centralized around one company. That’s because the initial costs to starting a business can be so high that only few firms to one can have access to such expensive resources. In other words it might be possible that it’s more efficient for few firms to produce a large quantity of a good than for many to produce few.

If we think about modern healthcare, people want to rid themselves of diseases and sicknesses using the best treatments – which may be equivalent to saying the most expensive forms of treatment. Those are high costs that medical centers – that wish to remain effective, open, and operational – must endure. It would be no surprise to me if the healthcare industry is one where centralization is natural – rather than a decree of government.

Christopher Espinal an economics student at the University of Chicago. He can be reached at


  1. Wow...I realize that learning often means meandering through a forrest of rhetoric before finding the answer, but Espinal took the long path around a simple concept. Values are subjective (one mans 15 minutes saved is another mans waste of time).

    Tooo clever for me...

  2. @ eFinancial

    You may understand this, but Congress certainly doesn't. And neither does the general public.

    Which to me means we need more articles like Espinal's. Read it again, there is more there than you imply.

  3. Tommy C

    OK - I reread Mr. Espinal and you are correct he does make some good points. When he answers his own question "...what does it mean to lower costs..." with "...that has endless solutions..." he is headed in the right direction.

    But he uses the term centralized in what appears to be a reference to economies of scale, a very real and natural concept. Than later he describes centralization as "natural" versus "a decree by government." This seems to me to be referring to monopoly. And monpolies are not natural. So I hope he continues his studies.

    Regarding the general public, they may not understand the academic meaning of subjective value, but they understand "beauty is in the eye of the beholder" and they understand "I want what I want." They also understand that congress is using the power and force of government to get what it and its special interest groups want.

    So there is little use in explaining to the public that free market capitalism makes the best policy. The public is quite willing to let congress continue its looting as long as they think they might get a chance to use this power to get what they want. The public understands all too well that might makes right.

  4. There is something called a natural monopoly...where there are increasing returns to scale - which is what creates a monopoly. Sometimes government policy can create, unnaturally, increase returns to scale in sectors - causing an unnatural monopoly.

  5. Chris,

    A nice article, just wanted to add a few points that come to mind:

    1.) Healthcare/medicine may "naturally" be inclined toward centralization and bigness... if healthcare/medicine is to be equated with pharmaceutical remedies and the R&D associated with it. But even then it's questionable how much of that is a "natural" outcome and how much of it is an outcome caused by govt patent protection (monopoly granting for certain technologies). The key to understanding whether centralization is more efficient in this industry is to ask 'Why is healthcare special?' and it seems like examined in this context most of what we observe is an outgrowth of incentives provided by govt.

    2.) Anytime a new product/service is introduced into the market, a "monopoly" as been formed. But this isn't a harmful monopoly, economically speaking, unless the govt proceeds to protect its market from potential competitors. You mention "natural monopolies" in one of your comments but you omit this possible reason for their occurrence. Your particular explanation for natural monopolies highlighted the role efficiency plays in their realization... if you are implying that some monopolies, if natural, can be economically beneficial than I agree with you. I just try to be careful with how I use that word because most people assume monopoly is an inherently bad thing and I would say that generally speaking it is because generally and appropriately defined, a monopoly is something created and maintained via govt intervention. I don't even bother calling one company in an industry a monopoly because so long as competitors are not outlawed or regulated out of existence, even potential ones, the firm should operate efficiently and at the lowest cost possible.

    3.) You said: To lower the cost of healthcare is to lower the costs of its inputs and/or to increase the level of competition.

    I don't know if that's entirely accurate. The cost of healthcare to the consumer can be lowered by the lowering of profits to the healthcare provider, as well. If, ceteris paribus, Provider A makes $2 profit per unit and Provider B makes $3, then Provider A's cost is X + $2 and B's is X + $3 and so lowering the cost to the consumer is as easy as going with the "less profitable" Provider A. This is good if it occurs via competition, bad if it occurs via diktat from central planners.

    Additionally, competition alone is not enough to lower costs, it's simply one phenomenon that might contribute. Advances in technology (mechanical, chemical, management, etc.) also contribute, although it is of course competition or the fear thereof which incentivizes those advances and encourages their implementation once discovered. The only reason I mention this is because one argument the govt planners have cited for their further interventions in the healthcare market is that they want to increase "competition" widely-defined as # of providers, by creating a "public option." This is faulty logic because this additional competition would not result in lower costs but rather higher ones via distortions of the healthcare market and a driving out of business of actual, efficient private providers.

  6. Hello Taylor,

    I certainly agree with all three statements.

    As far as the last is concerned - I was unclear, or at least did not clearly mention that point in my article. I hinted at it by saying "Competition ultimately lowers the price unless a monopolistic firm can show benevolence to its consumers – a far stretching possibility."

  7. Chris

    Glad to see such a robust exchange of ideas. I sincerely encourage you to continue to write.

    The more I study economics the more it seems to me there are no natural monopolies as long as there are no government barriers to entry or exit in a business sector. My hat is off to Taylor who explained these concepts so well.

    As for benevolence, it only truly exists in a competitive market as is so eloquently stated by Frederic Passy (1861): "Some day all barriers will fall; some day mankind, constantly united by continuous transactions, will form just one workshop,one market,and one family...And this is...the grandeur, the truth, the nobility, I might almost say the holiness of the free trade doctrine; by the prosaic but effective pressure of [material] interests it tends to make justice and harmony prevail in the world."

  8. Efinancial,

    I certainly agree that natural monopolies rarely arise. I also agree that probably in most cases monopolies arise from governments creating barriers to entry.