SUMMATION

To sum up, the proper kind of services for business to provide are services that provide gain of state (or, what is the same, services in areas of choice).

All the familiar things that businesses do can be seen as efforts to provide gain of state: making cars, producing movies, publishing books and music, running restaurants, staging sporting events and fashion shows, building and managing vacation resorts.

Business is unsuited to provide, at least directly, to the community or to individuals, services for preventing loss of state or restoring lost state. It makes no sense for business to provide commercial fire-fighting services to the public.

Equally, the kind of services that it is appropriate for government to provide are services in areas of no-choice.

That is, the proper kind of services for government to provide are services that prevent loss of state or restore lost state.

All the familiar things that government does can be seen as efforts to MAINTAIN state, and RESTORE state: passing laws, including laws to protect the environment; providing courts of law; police; national defense; disaster relief; firefighting services; regulating business, so that business activities do not bring loss of state to anybody, including antittrust regulation that checks businesses from preventing
others from gaining state.

As society progresses, the number of areas of no-choice increase - think highways, electricity, internet; the need to prevent loss of state and restore lost state spreads to newer and higher areas of society; if technology makes new things possible, new rules have to be framed and enforced to maintain state; the role of government of necessity increases. This increase is not the same as expansion of government role in society - it is simply a consequence of the expansion of the areas that government is - and always has to be - responsible for.

DISTORTIONS

Examining the distortions when market principles are applied in areas of no-choice.

By Desaraju Subrahmanyam.

See the post 'Business, Government and Services' for an introduction to the terms 'state', 'area of choice', 'area of no-choice'.

ABSTRACT

Approaching services in areas of no-choice in the same way as services in areas of choice distorts the service. The supply, or the price (or both) become distorted. We illustrate these distortions through the California power crisis of the early 2000s. We then discuss the distortions in healthcare services. We conclude with a discussion of areas that are seemingly areas of no-choice, food and general insurance, which are almost completely provided in society through markets, yet do not suffer from distortions.


WESTERN ENERGY CRISIS

In the mid-90's, California began changing its power sector by ushering in deregulation. The objective was to increase competition and bring down prices. New rules called for the Investor Owned Utilities, or IOUs, (primarily Pacific Gas and Electric, Southern California Edison, and San Diego Gas and Electric) to sell off a significant part of their electricity generation to wholly private, unregulated companies. The buyers of those power plants then became the wholesalers. The incumbent utilities were still responsible for electricity distribution. They were now required to buy the electricity that they used to own themselves, through a newly created day-ahead only market, the California Power Exchange (PX). A total of 40% of installed capacity was sold to what were called "independent power producers", which included Mirant, Reliant, Williams, Dynegy, and AES.

But deregulating the producers of energy did not lower the cost of energy. Deregulation did not encourage new producers to create more power and drive down prices. Instead, with increasing demand for electricity, the producers of energy charged more for electricity; they used moments of spike energy production to inflate the price of energy. Signs of trouble first cropped up in the spring of 2000 when electricity bills skyrocketed for customers in San Diego, the first area of the state to deregulate. Experts warned of an impending energy crisis. The trouble spread statewide that summer, and Governor Davis began asking the Federal regulator FERC to probe possible price manipulation by power suppliers. In January 2001, energy producers began shutting down plants to increase prices. When wholesale electricity prices hit new highs and the state began issuing rolling blackouts, Governor Davis issued a state of emergency on January 17, 2001. This officially came to be called the Western Energy Crisis.

At no point during the crisis was California's energy supply [the sum of in-state generating capacity and out-of-state imports] less than demand. But California's energy reserves were low enough that during peak hours the private industry, which owned the power-generating plants, could effectively hold the state hostage by shutting down their plants for "maintenance" in order to manipulate supply and demand. These critical shutdowns often occurred for no other reason than to force California's electricity grid managers into a position where they were forced to purchase electricity on the "spot market", where private generators could charge astronomical rates. Even though these rates were semi-regulated and tied to the price of natural gas, the companies (which included Enron and Reliant Energy) controlled the supply of natural gas as well. Manipulation by the industry of natural gas prices resulted in higher electricity rates.


AN EXPERT'S TESTIMONY

S. David Freeman was appointed Chair of the California Power Authority in the midst of the California crisis. He had 40 years of experience with the electric power industry as a regulator, an official in federal and state government, and as the manager of large public utilities. In testimony submitted before the Subcommittee on Consumer Affairs, Foreign Commerce and Tourism of the Senate Committee on Commerce, Science and Transportation on May 15, 2002, he made the following statements:

"There is one fundamental lesson we must learn from this experience: electricity is unlike anything else in our economy. It is truly the lifeblood. Ordinary consumers and businesses alike CANNOT DO WITHOUT IT for even an instant [emphasis added]. Reliable, smooth electricity at a reasonable, predictable price is an absolute necessity. [This] makes opportunities to take advantage of a deregulated market endless. If Murphy’s Law were written for a market approach to electricity, then the law would state 'any system that can be gamed, will be gamed, and at the worst possible time.' And a market approach for electricity is inherently gameable. Never again can we allow private interests to create artificial or even real shortages and to be in control.

"The words competition and deregulation are seductive. They sound great but the reality we found in California was quite different. A public utility industry whose books are open to public inspection, who are legally responsible for providing reasonably priced electricity, and who did just that for decades, were replaced by companies that operated in secrecy, are accountable to no one (apparently not even their shareholders or employees), could sell or withhold power as they pleased and had no obligation to build new plants.

"Proponents continue to talk of the potential benefits of deregulation. In California we learned who got the benefits - it was the power marketers. As for the consumers, in 1996 when deregulation was launched, the consumers were promised a 20% rate reduction by April, 2002. Instead the consumers are paying rates that are 40% higher!

"Consumers of all sizes cannot be well served by blind faith in the market. Any market for electric power generation must be combined
with sufficient governmental participation to assure that the lifeblood of our society doesn’t operate in ups and downs. Such volatility and shortages may be acceptable for oranges or stocks but society simply can’t tolerate it for electricity. It is a public good that must be protected from private abuse. The system of public utilities with a duty to keep the lights on at just and reasonable rates set by regulators served this country rather well during most of the 20th century."


COMPETITIVELY PRICED ELECTRICITY

The distortion in electricity 'markets' is not limited to the Western Energy Crisis.

In an article published November 6, 2007 ("Competitively Priced Electricity Costs More, Studies Show"), the New York Times revealed that retail electricity prices had risen much more in states that adopted competitive pricing than in those that had retained traditional rates set by the government.

The source of the data was the Energy Information Administration. A non-profit advocacy group, Power in the Public Interest, used the data to compare prices in 13 states and Washington, all of which have adopted market pricing for industrial users, with the rest of the nation.

The difference in prices charged to industrial companies in market states compared with those in regulated ones nearly tripled from 1999 to 2007.

According to the New York Times, "The data are the latest to show that competition, which was promoted by big industrial companies and Enron as the best way to create competitive incentives to reduce prices, has instead resulted in higher and faster rising prices. Some big industrial customers have turned against the changes they once championed, saying that if markets produced lower prices they would favor them but that electricity auctions have not worked... In market states, electricity customers of all kinds, from homeowners to electricity-hungry aluminum plants, pay $48 billion more each year for power than they would have paid in states with the traditional system of government boards setting electric rates."


HEALTHCARE SERVICES

We can similarly see distortions in healthcare, which is approached as an area of choice here in America.

Healthcare in America is paid for, in general, and at least partly, by for-profit health insurance companies that sell insurance directly to the public; and it is provided, in general, by for-profit healthcare corporates. So there are actually two for-profit services at play for the public - the insurance service and the medical service. Both these services are distorted.

The distortions on the insurance side include denial of insurance coverage, bumping 'customers' from insurance coverage, denial of claims, densely-worded contracts, and business activity focussed on denial of insurance, bumping 'customers' from insurance and denial of claims (inflating administrative costs thereby).

Imagine a business investing its energies in DENYING service to customers, rejecting customers and chopping customers! It is a travesty, yet this is what health insurance companies do. Why? Because there is no genuine customer, and there is no genuine business!


The distortions on the medical side include unnecessary 'care', and sky-high 'prices' of care.

Unnecessary medical care takes the form of unnecessary tests and procedures, unnecessary drug prescriptions, even unnecessary hospitalization. Tests, drug prescriptions and hospitalization do not add value for the customer, they are not a legitimate provision of services for gain of state. Yet when provided by a for-profit business, they are 'billed' willy-nilly, exactly as if more of them meant more gain of state to the consumer, like a car packed with goodies, extras and doodads - in short, as if more is better. Doctors focus on billing when that focus has no relation to the requirement they have to cater to, which is to prevent loss of state and restore lost state.

In his book Shock Therapy for the American Health Care System, Robert Arthur Levine, MD points out that there are two factors that make up 40% or more of the health care dollars spent:
1. unnecessary care
2. administrative costs of insurance companies.


As for sky-high 'prices' - benchmark the prices paid for lab tests and pharmaceuticals in the US against prices paid in other industrialized countries, where there is no direct for-profit mechanism applied to healthcare. Compare the differences with area-of-choice products and services like cars.

The price of the drug (or the test) does not represent any gain of state to the consumer; there may be a high cost to creating it, but this is not necessarily the case, and when it is not, the high price reflects one thing and one thing only - the lack of choice or the helplessness of the consumer over using the drug.

There is not a single known case of a country that has a largely free market, for-profit healthcare system organized on the lines of, say, the US auto industry, that delivers decent healthcare to the general population (to the common man, or the Average Joe / Jane) in the same way that decent autos are delivered.


FOOD AND CHOICE

If applying market principles to areas of no-choice distorts the supply and the prices, why - it can be asked - is the food market not distorted? Is food not the biggest area of no-choice?

We argue that the food market escapes the prediction of the no-choice model because the food market is actually a food item market, and every food item is, to a large extent, an area of choice rather than an area of no-choice.

Food is - for civilized man - at once something that prevents loss of state (proximately by staving off hunger, and ultimately by repleneshing body energy) and something that brings gain of state (by sensual pleasure in the combination of taste, texture and temperature). Food available in the market caters at least somewhat to the gain-of-state aspect - its selling proposition at least in part is the gain of state it gives you. Of course the gain is different for different food items and markets - it is lower for 'basic' food items such as vegetables or bread, which in themselves offer lower gain of state, and it is higher for 'exotic' food items such as restaurant foods, which offer higher gain of state.

The principle of dimishing gain-of-state applies to food items - the consumption of any food item reduces the gain of state on the subsequent consumption of the same item (but different food items have different gain of states). However, we have to eat 'food' - as distinct from any particular food item - everyday to prevent loss of state. The principle of diminishing gain-of-state does not apply to 'food' (that is, marginal utility is meaningless for 'food'). The net effect is that we eat a variety of food items, and the extent of the variety is given by what we can afford. The gain-of-state aspect of food translates into demand for a variety of food items, ACCORDING TO THE CURRENT LEVEL OF THE ECONOMY. On the other hand, people will eat the same food item everyday when they eat to stave off hunger.

Insofar as food items provide gain-of-state, they are a legitimate area of business. But where there are food shortages, say on account of droughts or floods, and people are starving or dying of starvation, any item of food is needed to prevent loss of state; there people need food items to stave off hunger and death, not to enjoy the sensual pleasure of eating. Therefore, although many people may need food in such situations, that is not 'demand', and is not a legitimate area of business.

People have no choice but to eat food, but even in basic (raw) food-products there is some real choice, a real variety of options: you can eat wheat or rice or cereals or meat or nuts or vegetables or lentils or eggs or fruits or dairy products or fish - each has its own distinct economic, geographic and cultural characteristics: know-how, supply levels, sources. Further, foods like vegetables, lentils, fruits, meat and fish come in many varieties of their own. To stave off hunger you can eat any of these foods and you can eat them in any mix. This 'choice' comes from nature - both the nature that is out there, the environment, and the nature that is in here, human nature. The environment provides a wide variety of possible foods which humans harness; and humans are adapted to taking a wide variety of food.

(Economists call this variety of consumption options as 'substitute goods'.)

You can eat less KINDS of food, and more KINDS of food.

Further, within broad limits, you can eat less, and you can eat more (although you may not eat as much as you need to or want to). Food consumption has high proportionality of quantity.

This vast, powerful choice in the hands of consumers prevents distortion in the food market.

The other important point is that in the case of food, the choice of substitute goods is with the consumer - the consumer has choice over what to buy, how much to buy, when to buy, how often to buy - or not to buy at all.

Healthcare is not at all like this. if you get malaria you do not have a meaningful, economically distinct choice of 'a' or 'b' or 'c' or 'd' or 'e' to cater to it; nor can you make-do with some 'mix' of them. Even if there are substitute goods (alternative drugs or therapies), the consumer has no choice over what to buy, how much to buy, when to buy, how often to buy. He or she always has to buy what somebody else tells him to buy, and ONLY what somebody else tells him to buy.

(Food is a good illustration of 'gray area', which was described in the earlier post 'Business, Government and Services'. With food, the area of no-choice and the area of choice are not absolutely distinct; it is difficult to tell apart the two services except at the extremes. Whereas 'food', in the abstract, is an area of no-choice, any actual item of food is largely an area of choice. So if the food business escapes the prediction of the no-choice model, it is because, very likely, the food business actually services an area of choice and not an area of no-choice, or it services what becomes an area of no-choice only in an extreme sense and in extreme cases of shortage.)


GENERAL INSURANCE

The other area that escapes the prediction of the no-choice model is general insurance - that is, insurance for cars, homes, factories, farms, art collections and so on.

General insurance is a service for restoring loss of state, and therefore falls in an area of no-choice. But the market is not greatly distorted.

There are reasons for this. As we discussed in 'SERVICES, PROPORTION AND PRICE', there is magnitude of choice and no-choice. If your car requires a denting-painting job, there is loss of state, but not of high magnitude; correspondingly the force of no-choice is not very strong. It is possible to get by without restoring state for a few days or weeks. This helps to keep auto insurance (by and large) from becoming the horror story that healthcare is.

But there are other, perhaps more powerful, factors. For one, general insurance is almost entirely concerned with states that can be and are priced; thereby the price of restoring lost state can be derived from, and is limited to, the price of gaining state. For another, general insurance such as auto insurance is usually mandatory by law, which makes for a large, 'assured' customer base. These factors have a beneficial effect on both price and service.

Mandating that everyone buy insurance sounds innocuous, but as a principle it is a massive distortion of the market principle that the consumer has a choice between buying and not buying. However, it acts as a counter-distortion to the original distortion, and can be effective in making for a functioning market and service, as with auto insurance, or indeed, health insurance as in the Swiss system.

UP NEXT: Summation

IDEAS FOR THE HEALTHCARE DEBATE

I argue that there is something about healthcare services that makes them fundamentally unsuited to be provided directly to the public by for-profit business.

That, in general, there is a kind of services that are unsuited for for-profit business to provide directly to the public, and a kind of services that are indeed suited for for-profit business to provide.

And that, in general, we can say the same thing of government: there is a kind of services that are unsuited for government to provide, and a kind of services that are rather suited for government to provide.

I propose a rather simple principle for deciding either way. It lies in the question: do you have a choice about the service? Can you choose what to buy, when to buy, how much to buy, how often to buy?

If yes, for-profit business does a better job of providing it (and government does NOT). If no, it is government that rather does the better job (and not for-profit business).

I develop this argument in a series of blog posts here on Wide Avenue. For convenient navigation, I provide a series of links to the posts. Please follow the links in sequential order:


BUSINESS, GOVERNMENT AND SERVICES

SERVICES, PROPORTION AND PRICE

MARKET AND AREAS OF NO-CHOICE

MARKET AND AREAS OF NO-CHOICE

Examining the applicability of 'market' to services in areas of no-choice.

By Desaraju Subrahmanyam.

See the post 'Business, Government and Services' for an introduction to the terms 'state', 'area of choice', 'area of no-choice'.


ABSTRACT

We argue that for products and services in areas that are inherently areas of no-choice, the concept of the market does not apply. In particular, the notion of 'price' does not apply. Thereby we move towards understanding WHY areas of no-choice are best left to government, and areas of choice are best left to business.


COMMUNISM, BUSINESS AND CUSTOMERS -

Imagine holding a gun to a businessman's head, and telling him to provide a service. Imagine telling him what to provide, when to provide, how much to provide and how much to charge - or else. Would he be able to properly provide the service?

Of course not, and we know what kind of economic system that is: communism. A command economy is essentially no different from putting a gun to the head of a businessman. The condition that the businessman has choice in making investment decisions and other business decisions

such as pricing is vital to the proper production of the service. When choice is removed from the businessman, it distorts the production of the service and makes it a travesty.

The condition of businessmen having choice defines the free market, and the free market is the most efficient system known to provide a stream of products and services to consumers.

Now imagine the gun on the opposite side. Imagine a consumer having a gun put to his head and being told to buy something. Imagine him being told what to buy, when to buy, how much to buy and how much to pay - or else. What would be the repercussions of that?

In the ideological war of the twentieth century between capitalism and communism, the principles of free enterprise and customer choice were vigorously championed in academic and public debate, and became part of the social consciousness in advanced countries. Communism was an assault on businessmen and their freedom, and on customers and their choice. (There is a story about a communist who tells a crowd, "After the revolution, we shall all have strawberries and cream." A man in the crowd says, "But I don't like strawberries and cream." The communist replies, "After the revolution, you will have strawberries and cream, AND like it.")

But customer choice has a flip side - namely, customer no-choice: there are products and services that people have no choice but to obtain.

In such areas of no-choice, the 'customer' is exactly in the position of having a gun put to his head. Of course, the gun is not there because of ideology, it is there owing to a complex of factors including sheer chance, and though human volition and action can be one of the factors (particularly with victims of crime), that human action is not intended to force the victim to seek a service. YET THE EFFECT IS THE SAME: no choice. For such products and services, the concept of 'market' does not apply. The condition that customers have choice in making purchase decisions and other economic decisions is vital to having a market system. When choice is not available to the customer, it undermines the market and all but makes it vanish.

But this appears not to have been clearly recognized - or at any rate has not been forcefully articulated - in public debate. In all discourse, the notion of 'market', with its underlying principles of choice, price and competition are applied willy-nilly to all products and services, without regard to distinctions of choice and no-choice between them.


CONSUMERS AND CUSTOMERS

At this point, we make an important distinction between 'consumers' and 'customers'.

A consumer is a person who USES a product or a service. A customer is a person who CHOOSES a product or service.

Products and services have consumers, and businesses have customers. (By 'business' we mean a for-profit commercial enterprise.)

Not all products and services in society are consumed by choice or provided by businesses, therefore not all consumers are customers.

A customer, however, is always a consumer.

Thereby we DEFINE customers on the basis of the choice they can make, and this definition formalizes the fact that choice is as vital to customers as it is to businessmen; without it, there is no more a customer than there is a businessman.



CUSTOMER CHOICE

The question can be asked: what is the meaning of 'customer choice' when the customer has limited means at his or her disposal to purchase?

How can we say that a customer is 'choosing' something when his or her purchases are dictated by the means at his or her disposal? When a person buys a small car but really wants a big car and cannot afford it, is that 'customer choice'?

The answer is that though the members of an economy are of limited means, every member plans for and chooses what to buy, and when to buy it, from among many different options. The ideal member would purchase everything that gives him or her gain of state, all the time. Real members, however, have to trade-off what to buy and what to forego, how much to buy and how much to forego, when to buy and when to forego, how often to buy and how often to forego. The economy offers the member a range of products and services from which he or she decides on a few, and plans on buying (the higher the level of the economy, the greater the range). It certainly is not 'customer choice' when a person buys a small car while he or she really wants a big car and cannot afford it. But every person chooses from among the many possible ways in which he or she can spend his or her limited means. 'Customer choice' is WHAT THE CUSTOMER CHOOSES TO DO WITH HIS OR HER LIMITED MEANS (including just saving his or her means instead of buying anything.)

That is 'customer choice' in the broadest sense. There are narrower and narrower senses. When a member buys a car, he or she chooses having private transport over using public transport and saving the money (possibly to buy something else). Narrower yet, he or she chooses a car over a bicycle or a moped. And narrower yet, he or she chooses a certain make and model of car over other makes and models. All these are 'customer choices'.

Correspondingly, businesses compete to sell to members with limited means; they compete over which product or service the consumer will choose to spend his limited means on. In the broadest sense, every business is in competition with every other business to attract customer choice. It is only in the narrowest sense that a carmaker competes with another car maker for customers.


PRICES

We now make the argument why, for products and services in areas of no-choice, the concept of 'market' does not apply.

The market system is premised on the existence of certain conditions described in economic theory, using the concepts of marginal utility, diminishing returns, supply and demand, price and allocation of resources based on prices. These conditions obtain only when customers have CHOICE in making purchase decisions: what to buy, when to buy, how much to buy and how often to buy - or not buy at all! When customers do not have choice in making purchase decisions, the conditions for a market do not obtain.

Let us focus on the cornerstone of the market - prices. The market consists of businessmen and customers, and prices have meaning for both of them.

To the customer, prices indicate how much gain of state is possible for him or her, at any given time and place.

To use the terms defined in this blog, price is a measure of gain of state; in general, a higher price indicates that a higher gain of state (value addition) is attained by the consumer. If a product offers higher gain of state, consumers choose to pay higher prices to buy it. If a product is priced higher than the gain of state it provides, the consumer will generally not buy it, and he or she is able to not buy it because he or she has a choice in the matter. Therefore, in general, products and services are not priced higher than the gain of state they provide. For their part, businessmen charge higher prices to provide higher gain of state; in general, they do not charge prices lower than the gain of state provided, and they can do this because they have choice in the matter. Therefore, in general, products and services are not priced lower than the gain of state they provide, and it is possible to attain an equilibrium price.

But paying a price is loss of state, because it is loss of opportunity to gain any other state; to quote from an economics primer, "Consumers will be willing to buy a given quantity of a good, at a given price, if the marginal utility of additional consumption is equal to the opportunity cost determined by the price, that is, the marginal utility of alternative consumption choices." In this blog, we talk in terms of gain of state rather than marginal utility; therefore "Consumers will be willing to buy a given quantity of a product, at a given price, if the gain of state of consuming it is at least equal to the opportunity cost determined by the price, that is, the gain of state of alternative consumption choices."

So a consumer comes to buy when the difference of gain of state brought by the product and loss of state brought by the opportunity cost is positive - the greater the difference, the more likely the consumer is to come to buy (or, more consumers are likely to come to buy).

Therefore when gain of state is high, demand is high; and when price is low, demand is high. When gain of state is low, demand is low; and when price is high, demand is low. (Thus we can assert that if a service is priced higher than the gain of state it provides, the consumer will generally not buy it; the consumer 'knows' what price a service is 'worth' because he or she calculates the opportunity cost based on the prices of the other things he or she can buy with the money. These other things need not even be in the same sector of state; the consumer can weigh whether to buy a new dress or a new cell phone with the money he or she has. Thus all sectors of the economy are bound together in their prices, although the binding is neither rigid nor uniform.)

Further, when gain of state is high and price is high, the differential of gain of state and opportunity cost is low, thereby demand is low.

On the business side, the business incurs costs in making products available on the market. A businessman comes to sell when the difference of the sale price and the production cost is positive - the greater the difference, the more likely is the businessman to come to sell (or,
the more businessmen are likely to come to sell).

Therefore when price is high, supply is high; and when production cost is low, supply is high. When price is low, supply is low; and when production cost is high, supply is low. (Businessmen are attracted to areas of high demand by the high prices, and thereby a supply is soon established to meet the demand. From the social point of view, prices 'tell' businessmen what service is required, at any given time and place.)

Further, when price is high and production cost is high, the differential of price and production cost is low, thereby supply is low.

We have to note that both businessmen and customers are at bottom playing for maximizing gain of state. As money held represents opportunity to gain state, businessmen look to maximize money profit while producing and selling products and services; customers look to minimize money outgo while buying and consuming products and services.

Thus price is meaningful in areas of choice, and markets can exist. Indeed, prices make markets possible.


PRICES CONTINUED

But what is the meaning of price when the 'customer' has no choice in buying or not buying a product or service (or how much and how frequently to buy)?

The answer is: no meaning.

Why? Simply because, when you have no choice, you will pay any price! (In graduated terms, the less the choice you have, the higher the price you will pay.)

The meaninglessness of price in situations of duress hardly needs explication, but here is a simple scenario nevertheless. Imagine that a hurricane devastates an area. Applying conventional theory, the 'demand' for emergency services goes up, and hence the 'price' goes up.

For-profit businessmen who provide emergency services can charge high prices of rescue to people stranded in storm water, and get many orders. If that happens there will be many who cannot afford the high price of rescue, and will remain stranded. The point here is not that some will be left stranded; this is economics, and they are simply outside the demand-band (if you do not have the money to back up your requirement for products and services, your requirement does not constitute demand). The point is that the businessman can offer to rescue people for whatever price they can pay (as long as it is above his costs). It makes more business sense to do this than to ignore those who cannot meet the high price in full. And he can do this because there is no real value addition to the service; it brings no gain of state to which to effectively tag a price. This can be played at the other end as well - just as he pushes down prices for those who have less money, the
businessman can push up prices for those who have more money.

This kind of arbitrary pricing does not work when the consumer has a choice. A rational consumer is alert to the opportunity cost given by the prices of other consumption choices, and will not pay any price higher than what the service is worth. Further, a rational consumer will generally not pay an opportunistic higher price for a product or service that others get at a lower price. If the businessman insists on a higher price, the consumer will simply not purchase, and he or she can very well not purchase because he or she has a choice in the matter. This is one of the reasons why businessmen do not give away products and services for any price that is above their costs, although this would appear to guarantee profits AND attract more customers. Different customers will not and do not pay different prices for the same product or service. That is not 'price', and it brings us back to the fact that prices have meaning - they cannot be anything, anywhere, anytime. (This is not to suggest that prices are always absolutely uniform all the time and for everybody. To the contrary, price is continuously varied by businesses for many reasons. There are price cuts, special offers, holiday discounts; loyal customers, club members and war veterans get lower prices. But such variations are made according to some principle, and are far from arbitrary, "show-me-the-customer-and-I-will-show-the-price" pricing.)

In a situation of disaster or duress, such as hurricane devastation, a person will pay a higher 'price' for rescue even when others are paying lower 'prices' because he or she has no choice. Besides, the person cannot estimate the 'worth' of the service from the opportunity cost, because in a life-and-death situation there ARE no other consumption choices the consumer can consider spending his money on.

(Economists call this 'perfectly price-inelastic demand', and the demand curve is a straight line parallel to the price axis. What it depicts, at bottom, is a condition in which price has become irrelevant. In such a condition markets cannot exist.)

Therefore price is meaningless when the consumer has no choice. As price is meaningless in areas of no-choice, there cannot exist a market for products and services in areas of no-choice. And competition in areas of no-choice will not drive down 'prices'. Businessmen will cartelize rather than compete. (On the other hand, the surest way of breaking cartels and bringing in competition is genuine consumer
choice.)

In short, markets exist only when both the businessman and the customer are free to produce and purchase. (Or, at a simpler level, markets exist only when both the businessman and the customer are free to enter and leave.)

And this holds in almost all areas of no-choice: national defense, police, judicial system, public health, environment, money system - and individual healthcare!


MARGINAL UTILITY, LAW OF DEMAND AND OPPORTUNITY COST

Price condenses and captures all the phenomena of the market, such as marginal utility, law of demand and opportunity cost. A discussion of price is necessarily a discussion of all these market phenomena. If price is irrelevant when consumers have no choice, it means marginal
utility, law of demand and opportunity cost are irrelevant (or do not hold) when consumers have no choice. However, understanding marginal utility, law of demand and opportunity cost on their own terms reveals explicitly their inapplicability to areas of no-choice.

In economics, 'marginal utility' is the fundamental concept. This is the term for the desirability (or 'satisfaction' or 'benefit') of consuming an additional quantity of a product or service, say one more candy bar or one more vacation cruise. The greater the desirability of consuming one more of it (or consuming it once more), the higher is the marginal utility of a product or service. Some products and services have high marginal utility, and some products and services have low marginal utility.

In general, the marginal utility of products and services diminishes: with every additional consumption, the desirability of consuming yet some more of the same product or service decreases. This is the law of diminishing marginal utility. The graphical plot of the marginal
utility of a product or service against quantity consumed is a curve sloping downward as quantity consumed increases. Just as different products and services have different marginal utilities, they have different marginal utility curves: the curves have different starting points and different slopes dictated by the peculiarities of the product or service.

For products and services that prevent loss of state or restore lost state, however, the concept of marginal utility does not apply. When we consider services such as courts of law, police, national defense, firefighting and healthcare, we find that it is meaningless to identify the marginal utility. Such services are not 'desirable' in the same sense that a candy bar or a vacation cruise is - we do not get
the same kind of 'satisfaction' or 'benefit' by consuming them, though we 'need' them in their own way. Indeed, our greatest 'satisfaction' or 'benefit' lies in not having to use these services at all. Therefore it makes no sense to consider the 'desirability' of consuming an additional quantity of such services.

And the law of diminishing marginal utility all the more does not apply. Consider whether a person's 'need' for firefighting services, for example, diminishes after a round of consumption. In general, our 'need' for services in areas of no-choice is constant.

The law of demand is an important principle of economics which states that, for a given product or service, the higher the price, the less it is demanded. The amount of a service that buyers purchase at a higher price is less because as the price of the service goes up, so does
the opportunity cost of buying it. People avoid buying a service that forces them to forgo the consumption of other things. (The law of demand holds for a product or service only when all other factors remain unchanged - for example, the prices of other products and services must remain unchanged.)

The opposing relationship of price and quantity demanded means equally that the lower the price, the more the service is demanded.

Clearly, the law of demand does not apply in areas of no-choice. It is obvious that the demand for healthcare, for example, will not go down if prices go up. As healthcare is a requirement that crushes all others in its path, people will divert money to it by cutting down on all other purchases, and this makes the demand curve look less like the familiar negative-sloping curve and more like the special case straight line parallel to the price axis. Of course, this is possible only within certain limits, as for every rise in price there will be people who no longer have the money to afford it, and that means a decrease in demand by the very definition of 'demand'. However, the limits are broad enough to be significant.

But it is really in the other version of the law of demand that its inapplicability to areas of no-choice is strikingly apparent. According to the law of demand, the lower the price, the more the service is demanded. But the demand for healthcare will not go up if prices go down. People will not cut down on other purchases and prefer to visit doctors and take medicines just because the prices are lower (which
brings us back to the central fact that there is no 'utility' in such services as found in candy bars and vacation cruises).

We can also see, in the above, that the notion of opportunity cost is irrelevant for products and services that prevent loss of state or restore lost state. Where healthcare is concerned, we would not consider having less of it to buy more of something else, or postpone it to
buy something else now; we would go to the doctor as many times as it takes, get as many medicines as it takes, and undergo as many tests and procedures as it takes. Neither would we consider having more of it by buying less of something else: we would go to the doctor ONLY as many times as it takes, get ONLY as many medicines as it takes, and undergo ONLY as many tests and procedures as it takes.

The all-important condition for a market to exist is equilibrium between the businessman and the customer. The businessman always wants to sell at the highest price and produce at the lowest cost; the customer always wants to get the highest gain of state and buy at the lowest price. For any given product, there can be a price at which the impulses of the two are in equilibrium - AS LONG AS BOTH THE BUSINESSMAN AND THE CUSTOMER HAVE CHOICE OVER PRICING AND PURCHASE DECISIONS. When the customer has no choice in buying (or when the businessman has no choice in pricing), there is no price at which the impulses of the two come to equilibrium.

When consumers have no choice over purchase decisions, economists draw a vertical line for the demand graph and call it perfectly price-inelastic demand. When businessmen have no choice over price decisions, economists draw a horizontal line for the supply graph and call it perfectly price-elastic demand. This does not mean that they represent conventional market phenomena just as well as normal demand that exhibits the demand curve. They do not have the same legitimacy - they represent the boundary conditions where normal market phenomena have just about vanished.

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