Why a Government Intervenes in the Market for Healthcare

Question

All residents in the United Kingdom (UK) are automatically entitled to free public healthcare through the National Health Service. On the other hand, Singapore adopts universal healthcare coverage through a mixed financing system with individual payments and subsidies from the government.

(a) Explain why a government intervenes in the market for healthcare. [10]

Answer

A government intervenes in a market when leaving it to free-market forces yields an inefficient — or inequitable — outcome. In the market for healthcare, three justifications stand out: healthcare is a merit good generating positive externalities, the market is afflicted by imperfect information, and intervention also serves the government’s equity objective.

Positive externalities. Healthcare is a merit good whose consumption confers an external benefit on third parties, and so will be under-consumed if left to the free market. The clearest case is herd immunity: when one person is treated or vaccinated, the transmission of disease to others falls; as fewer people fall ill, workplace productivity rises and firms gain. Because this third-party benefit is unpriced, the marginal social benefit lies above the marginal private benefit, producing the positive externality shown below.

At the market equilibrium, consumers consume $Q_e$ where $MPB = MPC$, maximising private utility. But at $Q_e$, $MSB > MSC$: society values an additional unit of healthcare more than it costs, so a deadweight welfare loss of area ABC arises from under-consumption. Welfare is maximised only at the social optimum $Q_s$, where $MSB = MSC$. Because the free market fails to allocate resources efficiently, the government intervenes — for instance through the subsidies and direct provision set out in correcting positive externalities.

Imperfect information. The healthcare market is also afflicted by imperfect information, in which consumers’ perceived marginal private benefit ($MPB_{\text{perceived}}$) falls short of their actual marginal private benefit ($MPB_{\text{actual}}$). Misinformation — the anti-vaccination movement circulating on social media is a salient example — leads consumers to underestimate the true private benefit of healthcare, driving a divergence between perceived and actual benefit. Deciding on perceived benefit, consumers settle at $Q_{e'}$ where $MPB_{\text{perceived}} = MPC$, below the truly optimal private quantity $Q_e$ where $MPB_{\text{actual}} = MPC$. The result is under-consumption and a deadweight welfare loss, a further ground for the government to act by levelling information through regulation and moral suasion. (This market failure is examined in prose: the 9570 syllabus carries no imperfect-information diagram.)

Equity. Finally, the government may intervene on equity grounds. Healthcare is widely regarded as a necessity, so a fair distribution of welfare requires that all consumers — including lower-income households — can access it. Intervention through subsidies and a mixed-financing system, as in Singapore, improves equity and so advances one of the government’s microeconomic objectives. This motive is especially weighty in economies with high income disparity (a high Gini coefficient), where a larger share of the population would otherwise be priced out.

Conclusion. The government intervenes in healthcare because the free market under-allocates resources to it — through the positive externality and through imperfect information — and because an unregulated market would leave essential care out of reach for poorer households. Correcting these failures, on both efficiency and equity grounds, is the rationale for the subsidised, universally accessible systems seen in both the UK and Singapore.