How government efforts to lower prices can lead to increased costs
Published March 24, 2021
By Andy Jackson
There’s an old adage that goes “there’s no such thing as a free lunch.”
Several insightful lessons can be gleaned from it, but one that has particular use for public policy debates is that it highlights the critical difference between prices and costs.
In this case, although the price to the consumer of the “free” lunch may be zero, the lunch is not costless.
The chef’s time, for example, plus the time and effort required to produce and transport the ingredients to the consumer’s location need to be reimbursed in some form. If those costs are not reimbursed by a price paid by the consumer, then they’ll come out of the restaurant’s bottom line.
The finished lunch doesn’t just appear, ready to eat, without any costs to anyone simply because there was no price paid by the consumer.
And perhaps more importantly, there are opportunity costs involved with producing the lunch. Opportunity costs are those goods and services that were not produced because scarce resources were devoted to something else.
In this case, the time, raw materials, ingredients, money, and other factors utilized in making the lunch are no longer available to produce other goods or services. It’s the highest valued opportunity foregone that specifically constitutes the opportunity cost of making the lunch.
Regardless of the price charged to the consumer, all goods and services involve costs, and those costs have significance because of the opportunity costs involved.
The difference between price and costs was highlighted in this Feb 24 Carolina Journal column by John William Pope Foundation president John Hood.
“Most people associate lower ‘prices’ of goods and services and lowering their costs,” Hood wrote. “But this isn’t necessarily the case. Indeed, government efforts to lower the price of a good or service can often increase their costs to society.”
One example, Hood notes, is the cost of college. In an effort to make college more ‘affordable’ to students, the government subsidizes the universities, and at times even mandates lower tuition.
“But that would constitute only a lower price, not a lower cost,” Hood points out. “The actual cost of delivering education consists of the resources consumed in paying employees and vendors, purchasing supplies and equipment, and otherwise running the campus.”
And with the actual consumers of the education shielded from the total costs, along with government subsidies flowing into their coffers, universities face little incentive to economize. Those “actual costs of delivering education” could quickly spiral upward, with universities spending more and more on elaborate campus luxuries that look good in glossy brochures but do little to improve education quality.
As these actual costs swell, so too do the opportunity costs. What other goods and services is society deprived of because so many resources are tied up in higher education?
More importantly, are those foregone goods and services valued more highly by society than the cushy student centers popping up on campuses? Because government subsidies are politically motivated and not guided by the market test, we can’t know for sure. But if the answer is yes, society is made poorer as a result.
Similarly, programs like Medicare and Medicaid sold as making health care more “affordable” may dramatically lower the price of health care to enrollees, but very well may increase the costs to society of delivering care.
A third-party payer system like Medicaid severs the tie between medical care consumers and the payment for medical services, eliminating a critical check on consumption.
One result is a major expenditure on unnecessary tests and procedures. This 2017 healthcare finance article estimated the amount spent in the U.S. every year on unnecessary testing and care was as much as $200 billion. When someone else is paying, it’s much easier to agree to services that are not really needed.
The price of all this unnecessary care to the patient may be little to nothing (depending on their insurance coverage), but the costs are significant. Someone needs to pay for it. And in the case of Medicaid or Medicare, it is taxpayers footing most of the bill.
Moreover, imagine all of society’s unmet needs that could have been satisfied if scarce resources had not been tied up in unnecessary medical tests and procedures. The opportunity costs are huge.
Also, when prices are interfered with by government policy, nonprice costs will emerge. For instance, in Canada’s “single-payer” health care system, in which patients are shielded from the price of care by taxpayer-funded payments, long waiting times are the norm. This Dec. 2020 Fraser Institute study reports that “Specialist physicians surveyed report a median waiting time of 22.6 weeks between referral from a general practitioner and receipt of treatment.”
The pain, discomfort, and anxiety of waiting more than five months for treatment is a steep cost paid by the patient in order to shield her from the full price of treatment.
When politicians enact or expand programs claiming to lower the “costs” of things like health care, college, housing, etc., it is critical to recognize that they really mean lowering the “price” of that good or service to certain people.
And their efforts to do so often come at a very steep cost to society.