Mental Transaction Costs

I have a new essay on mental transaction costs.

Perhaps consumers are ignorant about health care prices for a reason. When it comes to relieving pain and suffering, we do not want to take on the task of deciding between treatments based on price. Imagine having to ask yourself how much pain you would be willing to endure to save an addition $500. Or trying to choose between a high-cost treatment that is certain to work and a lower-cost treatment that has only a 75 percent chance of success.

Allowing our treatment choices to be made for us by doctors, with insurance companies in the background negotiating prices and determining what will be covered, saves us on mental transaction costs. We prefer to obtain health care without having to make cost trade-offs.

Please read the whole essay before commenting.

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9 Responses to Mental Transaction Costs

  1. Handle says:

    Medium CEO Ev Williams said

    There’s a reason we don’t subscribe to TV shows or our favorite bands individually: 1) It would be a pain in the butt …

    But wait, I do exactly this via Amazon already, and so do a bunch of folks around my office, and it’s easy as pie. Some people buy seasons of The Walking Dead, and others buy access to the entire HBO channel so they can watch Game of Thrones, Westworld, etc., but without having to pay for a lot more aggregation (i.e., cable TV) they don’t want.

    Hard to tell if that kind of purchasing behavior is becoming or will become typical, or, in the alternative, will remain the province of those with very big “mental transactions” budgets.

    Which raises another issue. I’ve written before about the “accessible society” which arranges institutions to have adequate and suitably cognitively-digestible options for most people, and to avoid predations along the lines of Scott Adams’ “confusopoly”. If you turn life into a chess game, only people good at chess (or clever, tricksy schemers) – and for whom investing the effort to win various games is almost always worthwhile because to them it is easy and low cost – will thrive.

    Likewise, there seems to be a market demand for “mental transactions costs avoidance,” but these people pay a price in unwanted cross-subsidies resulting from over-aggregation. Meanwhile, those with high mental transactions budgets will tend to choose a more tailored and limited approach.
    This won’t always correlate with intelligence or productivity, since some people who have high mentral transactions costs processing ability also have very high opportunity cost of the value of their time and attention, and also very low marginal utiltiy per dollar.

    So one might predict that smart people with lower or ordinary incomes (perhaps young ones early in their careers, or in low-compensation smart professions) would be more likely to pay mental transaction costs than other demographic groups.

  2. T Boyle says:

    I partly agree with your observation: there’s a cost to making a decision, and we will pay to avoid it.

    But that’s a very different thing to asserting that the entire population finds it too onerous to decide between medical treatments based on price.

    People are ignorant of healthcare costs because, for almost all of us, there is no point to having them – we can’t benefit from making decisions that incorporate price information. When people take on, for example, cosmetic surgery, they can and do make such decisions.

    This is not to invalidate a weaker claim you could make, which is that in a world where people could and did make choices incorporating price information, large numbers of them might still prefer to pay a service to do it for them.

  3. Fielding says:

    I’d agree with / extend Handle’s comments and T Boyle’s

    “Mental transaction costs” are probably a factor. But it’s sort of moot if transparent pricing and outcomes measures aren’t available.

    My understanding is that CMS regulations require you to charge all patients the same (Medicare or not) if you take any Medicare patients. You can collect different amounts, which is where commercial insurance contracting comes in. But the charges have to be the same…which is what is on the bill the patient receives. That significantly complicates pricing innovation, at least for anything that’s not super routine.

    So the limiting factor isn’t (or not entirely) the cognitive load of decision-making. It’s structural factors that limit the data that would support that decision-making.

    Now that I think about it, one of the pernicious results of bundling catastrophic health care with routine health care is that it eliminates the incentive to shop around for low-cost routine health care by pushing the routine care into the less flexible catastrophic pricing framework.

  4. Tom DeMeo says:

    What indicates that this is consumer driven?

  5. RohanV says:

    There are plenty of counterpoints to this mental transaction costs model. Places where the number of choices and costs have proliferated. Fast food, and restaurants, for example. Most places offer a far larger selection with different prices than they used to. Upsize your fries or not, etc.?

    Similarly, grocery shopping. Everyone is perfectly fine with buying different amounts of groceries, where costs change daily. There is very little demand for a service which simply ships you a box of food every week.

    Even in medicine, people are perfectly able to make choices when it comes to dentistry and veterinary services. I don’t really buy that they’re suddenly paralysed by mental transaction costs when it comes to a regular doctor.

  6. Bryan Willman says:

    Arguing in a similar direction – what if the question is actually undecideable, or undecideable by the typical citizen, even with complete transparency?

    “Mental costs” is probably a useful model, but I’d like to suggest undecideability may be a useful concept as well. (Think Godel, Turing.)

    Example – if one has an artificial knee, one’s knee surgeon is likely to suggest one take
    antibiotics for most procedures afterwards. But one’s other doctors often argue against it.

    Post implant infections are rare, but generally disasterous (often fatal.) But there’s no
    proof at all that antibiotics for most procedures actually prevent these infections.

    None of these people are fools. None seem to have any reason to harm the patient.

    Now, how does one decide whether to incur the cost of the antibiotics (which is trivial)?

    Perfect transparency of the current state of medicine does NOT actually allow computation of an optimum result.

    That is, perfect understanding of what the best doctors know would still leave one
    confused.

    In this light, how would one make treatment, let alone pricing, decisions?

    I’ll also note that in many fields of life, for protection of others, we don’t allow people complete freedom to decide for themselves. In most jurisdictions you don’t get to do your own major plumbing or electrical work without inspection/supervision by others. You don’t get to build a novel house without a certified engineer assuring it won’t fall down.

    These things are often much simpler than medical decisions, yet we think we’ll get better or cheaper medical care by pushing those decisions onto consumers?

  7. Benjamin Cole says:

    Interesting post.

    I am a pro-business kind of guy, but medicine is making me wonder.

    Suppose we assume doctors are rational, and thus maximize income.

    So they should advise the most expensive course of medicine possible, particularly if the treatment is likely to be successful (this garnishing reputation) or the patient’s case is terminal anyway (heroic efforts made, patients died and can’t talk about it).

    I am a smart guy, but I have a tricky time evaluating doctor performance. I recently had a tooth pulled, The roots of the tooth broke off, and had to be dug out. I think they used a jackhammer and buzz saw to get the roots out. Is this normal? I don’t know.

    I wonder if free markets always work—especially if we assume healthcare providers wish to maximize income.

    Let’s just copy the Japan model and be done with it.

    • Becky Hargrove says:

      And you probably had to pay more, to take advantage of the extra pain of the “jackhammer and buzz saw”! In the U.S. if a tooth looks like it’s going to break apart, we sign a form in case the dentist has to go the oral surgery route, such as in your case. If the tooth holds and comes out in one piece, the patient wins the “tooth lottery” by paying less, going home sooner and feeling better the next day.

  8. Richard Heyduck says:

    Once upon a time social institutions – I think of marriage and family as examples – came as packages of practices and procedures. As individualism increases, there is more demand for setting aside those institutions in favor of increased personalization. Greater personalization, having to design these institutions from scratch all the time, seems to be a place where mental transaction costs can come into play.

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