Uncertainty and the Welfare Economics of Medical Care (American Economic Review, 1963)

I. Introduction: Scope and Method

This paper is an exploratory and tentative study of the specific differentia of medical care as the object of normative economics. It is contended here, on the basis of comparison of obvious characteristics of the medical-care industry with the norms of welfare economics, that the special economic problems of medical care can be explained as adaptations to the existence of uncertainty in the incidence of disease and in the efficacy of treatment.

It should be noted that the subject is the medical-care industry, not health. The causal factors in health are many, and the provision of medical care is only one. Particularly at low levels of income, other commodities such as nutrition, shelter, clothing, and sanitation may be much more significant. It is the complex of services that center about the physician, private and group practice, hospitals, and public health, which I propose to discuss.

The focus of discussion will be on the way the operation of the medical-care industry and the efficacy with which it satisfies the needs of society differ from a norm, if at all. The "norm" that the economist usually uses for the purposes of such comparisons is the operation of a competitive model, that is, the flows of services that would be

Reinhardt, Chernew (general equilibrium)

offered and purchased and the prices that would be paid for them if each individual in the market offered or purchased services at the going prices as if his decisions had no influence over them, and the going prices were such that the amounts of services which were available equalled the total amounts which other individuals were willing to purchase, with no imposed restrictions on supply or demand.

The interest in the competitive model stems partly from its presumed descriptive power and partly from its implications for economic efficiency. In particular, we can state the following well-known proposition (First Optimality Theorem). If a competitive equilibrium exists at all, and if all commodities relevant to costs or utilities are in fact priced in the market, then the equilibrium is necessarily optimal in the following precise sense (due to V. Pareto) : There is no other allocation of resources to services which will make all participants in the market better off.

Both the conditions of this optimality theorem and the definition of optimality call for comment. A definition is just a definition, but when the definiendum is a word already in common use with highly favorable connotations, it is clear that we are really trying to be persuasive; we are implicitly recommending the achievement of optimal states.¹ It is reasonable enough to assert that a change in allocation which makes all participants better off is one that certainly should be made; this is a value judgment, not a descriptive proposition, but it is a very weak one. From this it follows that it is not desirable to put up with a nonoptimal allocation. But it does not follow that if we are at an allocation which is optimal in the Pareto sense, we should not change to any other. We cannot indeed make a change that does not hurt someone; but we can still desire to change to another allocation if the change makes enough participants better off and by so much that we feel that the injury to others is not enough to offset the benefits. Such interpersonal comparisons are, of course, value judgments. The change, however, by the previous argument ought to be an optimal state; of course there are many possible states, each of which is optimal in the sense here used.

However, a value judgment on the desirability of each possible new distribution of benefits and costs corresponding to each possible reallocation of resources is not, in general, necessary. Judgments about the distribution can be made separately, in one sense, from those about allocation if certain conditions are fulfilled. Before stating the relevant proposition, it is necessary to remark that the competitive equilibrium achieved depends in good measure on the initial distribution of purchasing power, which consists of ownership of assets and skills...