Health Care Economics 101: Does Price Transparency Work?
Policies promoting “consumer-driven health care” often overestimate the ability of patients to behave like shoppers.
There's been a lot of chatter about price transparency as a way to lower health care costs. Price transparency is a good thing, but as a way to lower health care costs? Hold on! Health care is not a commodity like other items you buy. Yes, we should have price transparency. For those patients who are able, comparing prices is a good thing. However, price transparency will not lower costs. It's because of basic economics.
Economics 101: Elastic and Inelastic Demand - Why Health Care is Not Like Buying a New TV
First some definitions:
Elastic Demand - Demand is said to be elastic when a small change in price leads to a proportionally larger change in the quantity demanded. Examples of highly elastic commodities include luxury goods and non-essential items such as designer clothes, high-price vacations, and eating at restaurants. Consumers can easily reduce and eliminate these items based on circumstances - rising prices, declining income, bad economy, etc.
Inelastic Demand - Demand is said to be inelastic when a change in price leads to a proportionally smaller change in the quantity demanded. Examples include essential goods such as food, gasoline, electricity. This is because even with rising prices, declining incomes, or bad economy, these items are necessary for daily living. Health Care is one of these items.
In conventional commodity markets, when price goes up, the quantity demanded by consumers falls significantly. But for many healthcare services, demand is relatively insensitive to price. Many studies have confirmed this. This means demand hardly falls when the price goes up. People cannot easily delay or forgo care in the same way they can forgo that Rolex watch or 80" TV.
Health Care Has Imperfect Substitutes and High Uncertainty
Health-care services often lack good substitutes, and the outcomes (benefits) are uncertain. A 1963 article by Kenneth J. Arrow “Uncertainty and the Welfare Economics of Medical Care” in the American Economic Review describes how risk, asymmetric information, and uncertain efficacy mean medical care is very different from typical goods. Arrow's findings still apply today. For many consumer goods you might say, “If the price is too high, I’ll buy a substitute or wait.” In contrast, for a needed surgery, diagnostic test, or urgent intervention, that logic fails: the “need” is pressing, the consumer lacks complete information, and the provider typically directs choice more than the consumer. The fact that providers know more than patients further limits the usual consumer-driven substitution behavior. When buying a new TV, there are many places you can go to get information about TVs like Consumer Reports. This is far less true for health care even with the internet and AI. If your doctor tells you that you need a medication, how qualified do you feel to offer a substitute?
Third-Party Payers Disconnect Patients/Decision-Makers from Price
With any other commodity, the consumer typically bears the full price and is thus price-sensitive. In health care, much of the cost is borne by insurers, governments or other third-parties. Therefore the patient's out-of-pocket cost is often much less than the price of the services and treatments and the consumer's decision is not based on full price so will exhibit different behavior.
Even with cost sharing strategies such as copays, deductibles, etc., the elasticity of demand does not change much. This is because of other issues impacting health care such as imperfect substitutes, high uncertainty and lack of information.
Is Health Care a Commodity Or Something Else?
Typical commodities such as electronics, clothing and food, can be classified as "normal" goods or luxury goods and follow clear income-elasticity patterns. But health care is complex. Some health care services and treatments are necessary (e.g., emergency care, urgent care) while other services are discretionary (e.g., plastic surgery). Elasticity of demand for general health care is low, meaning prices don't change demand. Health is not like a consumed good like food but is also "capital", meaning its an investment - you invest in your health to ensure you can work and be well so the economics of other consumer goods do not work for health care. Health care is more like an input into the production of health so can be viewed as a requirement.
Patient behavior in health care is influenced by a large set of factors rather than those factors determining whether they purchase that 80" TV.
Why Health Care as a Market Fails
Because of the factors I have described, health care markets suffer from market failures. This is due to information asymmetry (providers with the information, patients less so), uncertainty, external factors such as social determinants of health, and moral hazard (meaning lack of incentive to guard against risk where one is protected from its consequences, e.g. by insurance). Therefore, health care markets do NOT function like ideal competitive markets.
Consider too these other factors that play a role in consumer decisions that lead to market failure - provider behavior, institutional incentives, regulatory frameworks (complex in health care) and non-price attributes (e.g. reputation of providers, access).
Policy Implications for System Design
Because health care does not fit typical market-commodity behavior, designing policy or consumer-facing systems based on “normal” market assumptions (e.g., consumer will shop around when price rises) may mislead. For example:
Simply increasing price/cost-sharing may not significantly reduce utilization (or may reduce necessary care) because of low elasticity.
Providing more transparent price information may help in some elective settings (and indeed there is growing movement in “price-shopping” for certain procedures) but the structural factors (insurance, urgency, provider referral patterns) limit the effect.
Consumer education and engagement need to account for the fact that patients depend heavily on providers, have limited price/quality information, and face uncertainty—not the same as buying a consumer good.
From a system design standpoint, governance and regulation matter: because the “commodity”-model fails, relying purely on market competition to drive value may under-perform.
Conclusion
Maybe we need to rethink the solutions that have been proposed in recent years - e.g., price transparency, value-based care, direct-to-patient health care, etc. and consider the factors impacting a health care market to design a system that improves access to necessary care as well as services that are an investment in the health of our population. A healthy population is able to work and protect our way of life and therefore is worth the investment.