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From Goodman's blog on why Monopsony does not improve competition.

All over the developed world, the political left only knows two ways to constrain health care spending: (1) squeeze the providers and (2) deny patients care. Since they don't believe in markets or incentives or entrepreneurship — the ways costs are controlled in other markets — there really isn't much left to do but take it out on doctors and patients. Today I want to address the mistaken idea that suppressing provider incomes is a socially good thing to do.

Of all the arguments for national health insurance, the absolute worst one is the idea that a single buyer of health care can lower the social cost of care by exercising strong bargaining power. The Physicians for a National Health Program, for example, argues that a monopsonist (single buyer) will be able pay doctors, nurses, hospital personnel and other providers below market rates. [Doctors who want the government to stick it to doctors? Medicine seems to attract more than its share of masochists.  The only thing worse is an economist who hates economics. Read on.]

Paul Krugman, writing in The New York Times, uses a similar argument to advocate a public plan option in President Obama's government-run, government-regulated health insurance exchange. A public plan, he writes, would have the "bargaining power needed to bring down health care costs."

So what's wrong with this way of thinking?

Social cost is the sum of all the individual costs. That is, it's the cost to me plus the cost to you plus….. etc., summing over 300 million people. In doing the summation, we can't omit whole groups of folks. Although this may come as a surprise to some, doctors really are people! So are nurses. So are hospital personnel. Squeezing the incomes of providers shifts costs, but it doesn't lower them. It makes patients better off (in the short run) and providers worse off. But that does not lower cost for society as a whole.

As Gregory Mankiw explained in a recent New York Times editorial, if we want to shift costs, we do not need monopsonistic buying power. We could simply impose a tax on all the providers and use the proceeds to subsidize the health care purchases of patients. Good for patients and bad for doctors, perhaps. But since the gains and losses cancel out, the benefits for society as a whole are nil.

The obverse of a monopsonist is a monopolist. Suppose the federal government awarded a single company exclusive rights to sell domestic wine. The monopolist would certainly raise the price to consumers. But does this mean the social cost of wine would be higher? No. The consumer's loss is the seller's gain. The cost of production remains largely unchanged.

Social cost, in general, is independent of the prices people pay. The social cost of the production of a good or service is the value of the resources used to produce it.

The reason why economists — from Adam Smith to the current day — do not like monopolies and monopsonies is that they misallocate resources. Under monopoly, for example, too little of the monopolized good will be produced. Too much will be produced of other goods and services. The same is true of monopsony.

Another problem with monopsony in health care is that in the long run you get deterioration in quality. Suppressing doctor incomes encourages bright young people to enter professions other than medicine. In Britain, a very high proportion of doctors are immigrants — trained in some other country. Increasingly, that is true in the United States as well.