The premise for the market approach is fairly basic. At the moment in most countries (including the U.S. and New Zealand) there is no market for kidneys, and kidney donors are not directly compensated for their kidney. Effectively this means that, in the market for kidneys, the price is fixed at zero, as in the diagram below. At this price, the quantity of kidneys demanded (QD) is greater than the quantity of kidneys supplied (QS). So, there is a shortage of kidneys - not every patient who has a need for a kidney transplant is able to receive one. The waiting list for a kidney transplant is about 450 in New Zealand, and about 93,000 in the U.S.
If live kidney donors (or deceased donors' estates) were compensated for giving up their kidneys, this would remove the effective price control from this market. The market price for a kidney would rise from zero to P1 (in the diagram above). The quantity of kidneys supplied would increase from QS to Q1 (as at least some people who wouldn't have given up kidneys for nothing would choose to do so in return for compensation), while the quantity of kidneys demanded would fall slightly from QD to Q1 (the slight decline here is because demand for kidneys is very inelastic - there are few substitutes for a kidney [*]). There would no longer be a shortage of kidneys.
The welfare impacts are likely to be large. Without the market for kidneys, the consumer surplus (a measure the amount by which transplant recipients benefit from kidneys) is the area ABCO (plus the triangle above AB which extends above the top of the diagram), which is also the measure of total welfare because there is no producer surplus. If the market was allowed to operate (no pun intended!), consumer surplus would be ABEP1 (plus the area above AB), and producer surplus (a measure of the amount that donors benefit from the market) would be P1ECO. Total welfare would now be ABECO (plus the area above AB) - an increase of BEC.
There are other ways of demonstrating the gains from compensating kidney donors. A recent paper in the American Journal of Transplantation by Philip Held (Stanford), Frank McCormick (Bank of America - retired), Akinlolu Ojo (University of Michigan Health Systems), and John Roberts (University of California San Francisco Transplant Service) evaluates the costs and benefits of government compensation of kidney donors. The paper is very readable, and I encourage you to read it (it is ungated). It's also notable for having twelve supplements of additional material to the paper, supporting the analysis and conducting sensitivity testing. The abstract provides the best summary of the results:
From 5000 to 10 000 kidney patients die prematurely in the United States each year, and about 100 000 more suffer the debilitating effects of dialysis, because of a shortage of transplant kidneys. To reduce this shortage, many advocate having the government compensate kidney donors. This paper presents a comprehensive cost-benefit analysis of such a change. It considers not only the substantial savings to society because kidney recipients would no longer need expensive dialysis treatments—$1.45 million per kidney recipient—but also estimates the monetary value of the longer and healthier lives that kidney recipients enjoy—about $1.3 million per recipient. These numbers dwarf the proposed $45 000-per-kidney compensation that might be needed to end the kidney shortage and eliminate the kidney transplant waiting list. From the viewpoint of society, the net benefit from saving thousands of lives each year and reducing the suffering of 100 000 more receiving dialysis would be about $46 billion per year, with the benefits exceeding the costs by a factor of 3. In addition, it would save taxpayers about $12 billion each year.There's a lot that my ECON110 students can gain from reading this paper, as it makes extensive use of techniques we develop in a much simpler way in that paper. Among other things, Held et al. demonstrate that kidney transplantation is more cost-effective than kidney dialysis ($49,000 vs. $186,000 per Quality-Adjusted Life Year gained) for end-stage renal disease.
The overall conclusion though is again, that compensation for live donors of kidneys makes economic sense. Held et al. have a final comment for those who still hold a dissenting view:
Finally, we encourage those who oppose compensating kidney donors to place a monetary value on their concerns and to show how they outweigh the very large net benefits demonstrated by this analysis. If they do, they may discover—as we did in Supplement 6—that many of the arguments usually made against compensation of kidney donors turn out instead to be arguments in favor.
[HT: Marginal Revolution for the Held et al. paper]
[*] Although, it could be argued that the demand for kidneys would actually increase, because a kidney transplant can be expected to last only 10-15 years, after which the transplant recipient would require another kidney transplant.