jmherbenerIn the market economy, entrepreneurs are free to innovate to attract customers and customers are free to accept or reject their products and services. Given that there exist a variety of treatments with differing results, prices of outputs and inputs will adjust to economize the use resources devoted to each treatment.
Suppose there are two treatments for some neurological disease. One cures it completely with no recurrence in a single treatment. The other requires annual treatments for life, but it dramatically slows the progress, of the disease extending the patient’s life by several decades as the symptoms worsen steadily. There would be more demand by patients for the first treatment and, consequently, its price would be higher than that of the second treatment. In fact, because patients could borrow money against their future incomes, the price of the first treatment would be related to the present value of the stream of future payments made for the second treatment. So, its not obvious that a lifetime treatment would bring in more revenue than a onetime treatment. Regardless of which treatment generates greater revenue, the rate of return on investment would tend to be the same for either one. If the second treatment had a higher rate of return than the first, then investors would bid more for the resources to attempt to expand production. As a result, the price of the second treatment would fall and the costs would rise, both of which reduce the rate of return. When the rate of return in the two treatments is the same, then resources are efficiently allocated. Of course, if the costs of the first treatment are lower than that of the second treatment, no one will provide the second treatment.