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Adam Smith, the 18th century philosopher and economist, is often cited as the father of modern capitalism. As a system for organizing society, Smith’s interpretation of capitalism holds that the “invisible hand” of the free market will always and efficiently balance demand with supply through the collective market behavior of many buyers and sellers. From the birth of our democracy forward, Americans have embraced capitalism and enlightened self-interest as an essential guiding principal of self-governance; enshrined in the Declaration of Independence, the U.S. Constitution and generally unquestioned as central to the rights of citizens in a free society. As our elected representatives wrestle with the next iteration of modern healthcare regulation, it is instructive to review how Smith’s theory of the free market might inform policy related to the many markets that comprise the healthcare industrial complex.

At the core of free market theory is the concept of competition. In a free market, the voluntary exchange of goods and services allows each agent to compete with other agents for resources without external coercion or limitations imposed by government intervention. It can be argued that a truly free market is very rare in the 21st century global economy, even though free market theory is commonly used to frame debate and justify policy decisions that define the rules of competition governing markets.

According to Smith and a long line of economists to follow, free market competition has the following characteristics. First, economic agents compete for a share of the market by selling a product or service also provided by other free agents. Second, a single competitor is unable to control the market price of a product because other competitors are free to lower their prices to attract self-interested buyers to their lower cost alternative. Third, a healthy free market is composed of many competitors, not one or a small number of competitors that alone or in collusion can influence or control the “market price.” Fourth, buyers have complete information about prices and the relative merits of the competitive products offered in the market for that product (or service). Finally, a free market allows competitors and buyers to decide whether or not to buy or sell in the marketplace at all.

Under these conditions of “perfect competition” the market price for any given product or service is allowed to “float” or change in response to the value placed on each product relative to competing products by customers who are free to decide which product to buy given the known alternatives available. Free market competition then is characterized by an unregulated, natural pressure for the price of any good or service to hover at or near the market price. If a seller raises their price above the market price they risk that buyers will decide not to buy their product and seek a more competitive, lower cost option. This theoretical optimum price is determined by the outcomes of many buying decisions by many buyers across many sellers that together create the free market. Such a system is described as “self-regulating” in that the market price will naturally resolve to the optimum price point without external influence or regulation.

In this multi-part series, we will describe features of the current healthcare industry in the United States to the fundamental principles of classical free-market economics. One by one, we will compare the theoretical characteristics of free market competition to the reality of the modern healthcare sector. In our next article, we will examine the first requirement of a free market and the number and nature of competitors in different sectors of the healthcare industry. Please stay tuned in!

David J. Scarborough, Ph.D.
Assistant Professor of Management
School of Business
College of Professional Studies
Western New Mexico University
David.scarborough@wnmu.edu