Economic theory holds that if certain assumptions are met, then allowing markets to operate free of government interference will result in a state called pareto optimality. This is a state in which it is impossible to make someone better off without making someone else worse off. This is generally thought of as an “efficient” state of the world. Efficiency so defined, however, is only one measure of overall social welfare. The other is the public's satisfaction with the distribution of resources that results from reliance on markets, which is often referred to as equity. What assumptions must be met to ensure that a competitive market will lead to the highest possible levels of social welfare, which includes both efficiency and equity considerations?
Of fifteen assumptions (listed in Exhibit 4.1), fourteen are related to economic efficiency and one is related to equity. None of them is met in health care markets (Rice, 1998). So theory does not provide a justification for reliance on markets to improve efficiency in health care or to assure equity. Rather, such questions must be answered by examining each policy choice, compiling information on its expected effects, and drawing conclusions about the policy measures that will result in the highest gain in social welfare.
What has been missing in much past analysis is consideration of the range of assumptions necessary. It is well known, for example, that markets may fail to be efficient in the presence of a monopoly, or when consumers do not have good information. But