Does Uncompensated Care Raise Prices for the Insured?
Lifted from Robert’s Stochastic Thoughts comes this comment on Matt Yglesias:
by Robert Waldmann
Matthew Yglesias asks (Does Uncompensated Care Raise Prices for the Insured?)
. I am having trouble with moneybox comments so I comment here. OK first I have to note that a philosophy concentrator half my age is doing pretty well to make me think about economics. Yglesias’s willingness to think and write about technical subjects is a valuable national resource. This is also true of field specialists can respond to his arguments.
His argument
Think about the CVS downstairs from my office. It charges prices that it believes are profit-maximizing. Now suppose some indigent person comes in and burns all the magazines on their magazine rack for fun. The guy’s got no money, so CVS can’t recoup its losses. Does this force CVS to raise prices on Diet Coke to make up for the cost? No—CVS was already charging profit-maximizing prices, and past losses are irrelevant to determining optimal forward-looking pricing strategy.
Hmm logically this implies that people who live in high crime neighborhoods in which people do stuff like that don’t pay more for goods. But they do. So what is missing ?
Well first the thought experiment considers an unanticipateable cost and one repetition of which is not likely. Uncompensated health care isn’t like that at all.
Even a totally profit oriented for profit hospital chain will consider the forecast rate of unconmpensated care when deciding whether to invest in building new hospitals. A cost which doesn’t affect the marginal cost of a good or service and doesn’t in itself effect the elasticity of demand will affect entry, which depends on forecast average cost and not on marginal cost.
This will affect prices. The reason is that with higher unavoidable costs a higher ratio of price to marginal cost is required to convinced firms to enter.
Let’s imagine a socially useful application of Yglesias’s theory (if it were valid). Stealing from CVS and giving the the stolen goods to the median citizen would be a distortion free transfer from CVS shareholders to people on average poorer than CVS shareholders. This would cause increased welfare. I don’t think Yglesias thinks this would be a good approach.
I don’t think he thought the problem through to the end (oops I mean to the beginning — entry of firms).
slightly edited from Stochastic Thoughts
That’s a strange argument, especially since stores like supermarkets and drugstores often argue that problems like theft force them to raise prices for everyone.
Basically, the argument is based on the assumption that there is one optimal profit maximizing set of prices, perhaps fixed by God in the book of Genesis, and that no mortal action can influence it in any way.
If nothing else, insurance rates are likely to rise even after a single incident like that, and a sensible business person will have to make allowances for potential future losses, once a potential loss is realized. It’s called Bayesian statistics.
Arguing that businesses should not, do not and, perhaps, can not incorporate experience into their pricing schemes is a bizarre theory, belied by millenia of business behavior.
In fact, past losses can cause all sorts of severe problems. One of our local asian groceries was forced to close when the owner’s ex-husband trashed the joint. Maybe CVS is more than happy to make good any losses and only look forward, but real stores go out of business and have their cost structures, and therefore their optimal pricing strategy, influenced even by one shot setbacks.