Healthonomics: It's The Economics, Stupid

This is the conclusion of a seven-part series on how Health Care breaks typical economic models. You may find it helpful to start at the beginning.

I should have opened with this.

Economics is sometimes referred to as "the dismal science", and not without reason (although the reason has an awful lot to do with 19th Century Victorian slang, and... what was I talking about?). It is the hardest of all the social sciences, and by "hardest" I mean "math-iest" not "most difficult" (although some might use the two interchangeably), and I think it might be helpful to outline a few peculiarities to the discipline that give it such a skewed perspective of the world.

Again, I probably should have started the week of with this, but whatever. Live and learn, they say, or don't bother with either.

Economics is the science of decision-making. This is why incentives are so important to the study. An incentive is a push, not a mandate, and incentives are usually coming from opposing sides all at once (I want to spend money on this laptop, I also want to eat tomorrow), but they can produce some really bizarre results when no one's paying attention. In ways, it's a bit like vector addition. Let's say you and I run into each other as hard as we can. If I'm going East and you're going West then we end up keeping each other in check. On the other hand, if I'm going East and you're going North, we end up in Newfoundland. Or maybe I'm going East and you're going West in a Pinto and we both explode...

You think I'm exaggerating. Let's say I sell pizza. I have an incentive to make money selling pizza. You have an incentive to not spend a whole lot of money buying pizza. This keeps the prices reasonable. But I still want to make money, so I cut corners on sanitation. Then you get Ptomaine and die. And I got to prison. All thanks to the magic of incentives.

And speaking of magic... if anyone ever tells you about the "magic of the market", they have never studied economics. They have probably never read a serious book about it. There is nothing magic about it, unless you think of math as being magical, in which case you have no business studying economics. Most economic concepts can be reduced to applied abstract calculus. Supply and demand are always represented as a system of equations where both equations are quantity as a function of price (seriously, when sussing out someone's economics training, ask them about supply and demand--if they talk about fixed quantities, they're unschooled).

But that's just algebra, I promised you calculus. Here goes. Marginal cost is the cost of making one more unit, and it is figured by taking the derivative of the cost function. Marginal revenue is the money brought in for one more unit, or the price. Since revenues are figured by multiplying price by the number of units sold, then marginal revenue is also the derivative of the revenue function. If you want to maximize profits, you start with your equation for profits: revenues minus costs. Then take the derivative (marginal revenue minus marginal cost) and set it equal to zero. The math dictates that profits are maximized when marginal cost is equal to marginal revenue. And this turns out to be true. It makes sense to stop making new units exactly when the cost of making another one exceeds its price. But this also means that fixed costs, like rent, don't figure in when you're setting your profit-maximizing production numbers.

Which brings me to another point. Economics is often quite unintuitive, which should be evidence enough of its supreme physics envy (something a physicist would say: "Forget intuition, look at the math!"). Why is it this way? Honestly? Communism.

Your irony sensors should be going off right about now.

You see, economics was formalized in the 50's. An awful lot of math was infused into it because we wanted to prove scientifically that capitalism was superior to communism. There's nothing inherently wrong with this, I suppose, it's just that there aren't always a lot of readily available quanitifiables. Complex equations are helpful for understanding the mechanics, but actually generating those equations is part art, part science, part voodoo (but not magic), and when you do arrive at those equations, the numbers aren't pretty.

Sure, it's useful to understand that cost curves generally have the shape of third order polynomial, but it's a pain in the ass to actually nail down that equation so you can take a derivative.

Okay, enough seriousness. Next week, more light-hearted fluff. I promise.

]{p