Why isn't the supposedly "free market" actually free?

We all understand the symptoms of the problems, like effective price-gouging, but in order to do anything to fix the problem we need to find the root cause of it all. The first thing which comes to mind, and the most obvious answer to anyone who understands economics, is that the incentives in place are messed up.

http://hbr.org/web/extras/insight-center/health-care/redefining-competition-in-health-care

This article describes how and why competition is discouraged in a market where it shouldn't be. First of all, if a hospital is charging outrageous prices for procedures and supplies that only cost them pennies, then why aren't there other hospitals opening up around them? Charging half the price of the bloated institutions in place and "trimming the fat" out of administrative costs, new hospitals could drive prices down and still be incredibly profitable. As the article at the Harvard Business Review indicates, there is no single answer, and there is plenty of blame to go around (both in public policy and private decision making). But here are some of the highlights:

"Zero-Sum Competition"
In any free market, firms generally try to provide higher quality goods and services at lower costs to attract new customers and compete with other firms. But in the health care market, costs are simply moved around from those who can't pay to those who can. Since third-parties are bearing the brunt of costs, nobody seems to stand up and say anything, but no value is actually created from these "cost-cutting" activities.

"The Wrong Level of Competition"
The HBR claims that economic progress in health care occurs at the individual level; when doctors treat the same sorts of patients, they get better at what they do, contributing to higher-quality care at lower costs. But today, the competition occurs (often) in the health insurance markets; payers are trying to find ways to increase their profits, and since they are the ones paying for care, hospitals have no incentive (again) to increase the efficiency of their operations. Instead of patients looking for hospitals who offer the kinds of care they need at low costs, they look for the best insurance deals, and get stuck in whatever hospital happens to be nearby.

"The Wrong Objective"
Health care providers do, in fact, try to keep their costs down. But not by decreasing the cost of care, just by decreasing the costs they have to bear. This, in large part, is perpetuated by competition occurring at the wrong level, and these objectives do nothing to add value to the system as a whole.

The article goes on in much greater detail, and is a pretty interesting read. I highly recommend giving it a look if you are interested in understanding the issues underlying the surface problems discussed in the assigned article.