What Really Makes Prices Go Up?

During the last several years, we have experienced a general rise in the price of many goods (especially food) thanks to an increase in the price of oil.  Oil, of course, affects the price of many other items because oil ratchets up the cost of transportation, which is built into so many things that have to come to market.

But the price of oil is a tiny, little, marginal thing compared with the influence of another force.

One might have noticed that in real terms, most consumer goods are much cheaper (adjusted for inflation) than they were many years ago.  This trend is most notable when we consider how innovation has reduced the cost of manufacture and has given us gigantic value for the dollar spent on electronics, for example.

But prices have gone up radically in a couple of areas.  Health care has become far more expensive during the past three decades.  The same is true of higher education.  The rise in cost in both areas has been shocking.

How do we explain the increase in prices in these sectors as real prices have gone down in many others?  The answer is simple:  government subsidies.  The government injects gigantic dollars into health care through Medicare, Medicaid, and a variety of state and local programs.  Governments also provide tremendous subsidies to higher education via various forms of financial aid.  Those subsidies drive large numbers of additional bidders for goods and services into those markets where they push prices upward.  Only now are the market participants beginning to feel the bite.  The reason is that prices have gone up enough to counteract the effect of subsidies.

Let’s note that there are no really significant subsidies in an area like computers, televisions, cars, or even clothing.  Now, you can get more value than you could two decades ago for the same money.  The difference is substantial.

But in health care and higher education, you are paying more and more for the goods being sought.  We should note that there is an important exception.  What medical procedures have been getting cheaper?  Plastic surgeries and laser eye surgeries.  Both of them are largely unsubsidized.  No government aid or insurance, really.

All of this suggests that we have made a mistake by bringing so many government dollars into higher education and health care.  We don’t know what the market may have given us in the meantime.  But it may well have been more innovation and better service at a superior price.


8 thoughts on “What Really Makes Prices Go Up?

  1. I’ve been thinking the same things about higher ed. Especially as I’m paying a bunch of money in student loans. I don’t think the government making money for higher ed easier to come by has done many favors to eduction. I’d be interested in seeing where the big colleges and universities spend most of their money. Probably not on faculty but I’ll bet there has been a huge investment in dorms and dining halls. Just thinking out loud.

    • Tim, I think there are a lot of good answers to why, specifically, the prices have gone up so much. One thing is that schools have been in something of an arms race with regard to facilities. The buildings are much nicer. Dorms are far more private and well-outfitted. The IT costs are hugely higher than they were before. Accreditation continues to become more complicated and more demanding and more intrusive. There are many different sources of climbing cost in higher education.

  2. Electronics are consumer discretionary goods. Medical care and education are essential, as are oil and food. I do not see how government subsidies actually increase prices in market sectors that are essential. People demand health care because they need it. They demand education because they need it. There are no used product markets in these areas. There are used cars, computers, tvs, and clothes. In health care, demand remains constant but supply decreases, so you have higher prices.

    Yes, the difference is substantial, but it is because the level of actual need is different. Greed and unregulated costs have much more to do with it than Medicare, Medicaid, Pell Grants, et al. We have regulation of utility costs in many areas because utilities are essential. The profit margins in health care, particularly prescription drug companies, is staggering. We are the only industrialized nation that does not cap prescription drug costs.

    I recommend these two articles that examine health care and higher education costs respectively.

    • Todd, you are right to say that demand for health care is less elastic than demand for consumer electronics, but you are wrong to argue that the demand is constant. That is simply untrue. For your view to prevail, all illness and health needs would have to simply happen to people and never, ever be the result of lifestyle. Clearly, a great many illnesses and diseases are the result of lifestyle choices, such as eating and lack of exercise (which has harmed my own health). The other thing you are missing is the effect of subsidies on the behavior of providers. If they had to compete for your hard-earned money, they might be more innovative and more strategic about price than they are now.

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