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Lecture Notes
Secondary Markets: Hospital ServicesDefinitions and Trends
Types Federal vs. non-federal Community vs. long term Non-profit vs. for profit vs. state/local Other trends: from 55 to 80
Long term: D decreases substantially Community: D increases
65-75: D increases for all 75 to present: D decreases for all
Table 14.1, p. 306
Table 14.2: Changes in In Patient vs. Out PatientBecause decreased demand, must be more cost
consciousAlso decreasing occupancy rates and length of
stayOrganization
Use Non-profit as an exampleWhat if profit > 0?
Can make profits, just cannot distribute to owners => what to do with profits?
Who is the residual claiment (to the profit)? Hospital administration Patients ( Decreased P, increased Quality) DRS (increase their profit)
2 Separate Organizations
1st: Management Board of Trustees selects President and other
administrative staff
2nd: Medical Staff Comprised mostly of Drs. Drs. apply for privileges to admit patients, perform
procedures, etc. Privileges granted by staff
Who controls the hospital? Drs?Arguments in favor of Drs
If Drs. have privileges at many hospitals then bring patients => lots of power to get what they want…or leave.
Arguments against Drs/Favor Management More to be cost conscious due to decreased demand
=> More hospitals are relying on Drs as employees with
contracts with HMOs, employers to generate patients.
Hospital Cost InflationA. Trends in hospital cost inflation
Look at costs/patient days, costs/admission, and total expenses/capital
Note: these are not homogeneous => could be quality differences.
Table 14.2 shows the following general patterns (1) increase in costs occurred consistently through the
whole series => not a new problem (2) However, more of a problem post 1966 (larger
increases) (3) 1972-1974: not a problem during Nixon price
control years (4) Late 70s: real rate of increase lower although
nominal rate constant. Why? Book claims voluntary controls to avoid regulation but
not consistent with chapter on regulation.
(5) moderated even more during 80s, perhaps due toRecessionCompetitionPrice controls
Also, look at table 14.2 Hospital costs as a percent of total increase then
decrease Government share of costs increase/medicare Private insurance increase then decrease
Hospital Cost ShiftingHospitals provide large amounts of
uncompensated care. Why? Both legal and ethical reasons
Who gets it? Un-insured (most) Under-insured
Are these costs passed on to those who pay? (hospital cost shifting) Argument in favor is quite simple– must cover the
costs somehow => make up costs from paying market
Look at a simple profit-max model
2 markets representing 2 groups of patients
C1 = AC = MC R= Reimbursement rate for medicareR1 covers AVC but perhaps not ATC
$R1
R2
Q2 Q
MC=AVC
Medicare
$
P1
C1
Q1 Q
D
AVC=MC
Profit > 0
Private Insured/self pay
C1
Suppose now R decreases => P1 doesn’t necessarily change in SR because if P increase => profit decreases (Already at profit-max)
In long run, must be at least where TR= TC if R decreases causes TR < TC => must be a change which might increase P above P1, but if TR > R => no change in LR.
Hospital PerformanceDepends on…
Hospital costs Hospital incentives/objectives
Hospital Costs/Economies of Scale
Why do we care? Recall: essentially this is an issue of tech. efficiency How big must a hospital get to reach efficient scales
(MES)?
MES
LRAC$
Q
Or, put differently, are hospitals large because of (1) Economies of Scale => public policy =regulate(2) Lack of competition => Public policy = antitrust
Empirical- want to estimate LRAC => use multiple regression analysis Problems
Quality differences between hospitals Case mix different Hospital service mix available Severity of illness Input prices Educational hospital?
Want to find:
Why decrease and then increase?Specialization of inputs when Q is lowCongestion when Q highFind MES => compare to hospitals sizes for
efficiency.
MES
LRAC$
Q
Q: Why do we need to control for these other factors?A: Suppose we don’t =>
Assume severity of illness affects costs 2 cost structures
LRAC1: Low severity LRAC2: High Severity Choose 2 firms but don’t control for severity=> for
Firm A and B Get A being lower cost than B although not correct.
LRAC 2
LRAC1
$
A B
Q
ConclusionsInitially consensus = appeared to be slight economies
of scale with MES ~ 250 but LRC did not dip muchProblems discussed earlier especially WRT controlling
for theoretically relevant but unobtainable data destroyed this consensus Some raise possibility of diseconomies of scale
Survival analysis: if size of hospitals increase over time => must have some advantage like economies of scale. If decrease => disadvantage Survival analysis finds slight economies of scale in hospitals That is, smaller to medium size hospitals are more likely to
survive.
Theories of Hospital BehaviorBegin with simple profit-max similar to what we
just did in the previous section
(1) Profit Maximization with some monopoly power Basically get…
P
Q
MC
AC
DQm
Pm
PredictionsP increases if D increase or becomes more
inelasticHospitals minimize costs of productionIf profit > 0 => reinvest (since non profit) in
those with highest rate of return (expected)No entry barriers => profit = 0 in LR
Observations consistent with predictions?Did not observe cost minimizationInvestment is not consistent with model
Invested in services which lost money Plus cross subsidized low profit treatments =>
not minimizing costs (economies of scope)Barriers to entry must exist since not minimizing
costsWhat do physicians do? Model assumes a passive
role. This is not consistent either. Physician Control Model
Assume: Physician decides treatment mix as patient’s agent Patient doesn’t care what to mix or prices of inputs
only total price and output. Drs. may decide input mix to max own income or utility Or can view Drs as contractor and gets what is left over
after pay hospital its costs.
Suppose only two inputs (Dr and hospital)
Therefore, Drs control hospitals to max income
Q
MC
AC
D
P
Suppose D increases => how should hospital capacity change?
If increase hospital use but hold # of Drs constantMPdr increases while MPh decreasesDoctors can charge moreWhy? Basically gets paid on FFS basis. Hospital provides
more resources=> Dr can do more procedures=> increase dr productivity. Is this consistent with what happens in hospitals?
Appears to be
Qdr
Qmc1Qmc2
Qmc3
Drs
PredictionsDr wants increased services to increase MP
Consistent with observed data; get investment even though duplicative
Technologically inefficient Pricing policies
Hospital goods that are compliments => Wants low prices (he/she gets more of total
price) Goods that are Substitutes => high prices (since
competition) Is this consistent?
Q: Why are hospitals non-profit?Model says to increase Drs income?
How? 1st: decrease hospital competition ( may be only due
to legislation which requires Drs as part of the process)
2nd: if hospitals for profit=> hospital profit incentive competes with Drs profit incentive since the two are substitutes
Tying it all together– A model but really the synthesis we talked about before since all 3 actors will have an effectAssume U = (N, S)N= quantity (# of pays)S= quality (Service)P(N,S)= Patient’s Demand curve – as P
decreases N increases, as S increases P increases.
D1(S1)D2(S2)
D3(S3)
P
N
Assume a not for profit hospital and that costs =C = C(N,S) (C increase as N increases
and as S increases)Not for profit implies that TR = TC or P(N,S)
N= C(N,S) or P=AC
Effect of S on Costs
N
$ AC(S3)
AC(S2)
AC(S1)
Put the 2 together to get…
Why are intersection EQ points? (profit=0)EE=EQ combinations of P & N
AC4
D2
D4D3
D1
E
AC3
AC2
N
P
Note: if
=> cannot offer that quality level; not enough Demand
D2
AC2
N
P
Also if…
At both A & B profit=0 but at B, N is higher => choose B over A
N
A
B
D2
AC2P
Which is the best of the possible EQ points. Transform EE to look like…
S
N
F
S2
S1
N2 N1
F
Now put with U(N,S)
S
I1
I2
I3
N* N
S*
Utility max combination of N & S
Applications of the ModelSuppose an existing hospital increases its
quality? D for your high quality will decrease…why? D for your low quality will increase…why?
=>look at what happens at EQ points
E1E2
P
NN1N1’
AC1
D1D1’
S=S1
Low QualityN increases
p
N
D3’D3
S=S3
High Quality N Decreases
FF (old)FF (new)
S
SB
S1
N3 N3 N1 N1’
Same thing happens with entryIncrease insurance coverage
All Demand Curves increase (rotate) => EE shifts right
=> and if FF curve shifts out bother N & S increaseInteraction of Drs. And hospitals
Assume market for Drs is monopolistically competitive (profit=0)
but p > mc$
Q
MC
AC
DMR
But if hospitals decrease Drs…AC => Drs make profit as long as not low enough to induce entry.
How do hospitals decrease AC?By increasing quality
What do hospitals get out of this?Patients: hospitals increase doctors’ profits but
get patients in returnCompetition (how do hospitals compete?)
Old Style Patients have complete insurance (is this true)=>
they like more services and cost not an issue => attracting patients and Drs the same increased
quality and increased costs
New StyleInsurance companies more costs with PPOs,
DRGs, etc. => incentive for patients to be worried about costs Compete by lowering costs if efficient
=> increase efficiency lately
Why do non profits exist?Theory: recall that more P.C. => markets yield
efficient outcomes but if req. for P.C. violated => may need intervention Externalities Public goods: non-exclusive, non-rivalrous
But gov’t also leads to its own inefficiencies=> non profits
Public Good aspect of Donations1st: EQ Q of public good = level C
Why? Because extremely difficult to construct taxes so
that each voters MT = D
2nd: most voters are dissatisfied with either too little or too much provided =>room for voters to form non-profits to take care
of both types of inefficiencies from (1) private market and (2) gov’t.
Do healthcare markets have public goods?At the least easy to argue that hospitals,
nursing homes, etc. not pure private goods. Some external benefits => common for hospitals to begin as _________ institutions.
Other external benefits Quality Insurance to consumers Benefits to businesses
Theory– Contract Failure caused by asymmetric information Hard to measure Q and quality => for profit has
incentive to decrease to increase profit Use not profit to decrease that incentive
The Hospital in Labor MarketsRecall where D for inputs comes from (D for
services)HS = f(N, Drs.----)Drs need to have labor inputs….2 kinds
DL’DL
W
LNon-specialized => hospital a price takerIf DL increase => W
SL
DL’DL
W
L
SL
Specialized laborIf DL increases => W Increases
What causes DL to increase? Anything which cause DHS to increase (or QHS or
quality increases)
Another view of Nursing Shortages Exists if QD > QS
L
W
W1
SL
Qs QD
DL
But if W increases => Shortage disappearsSuppose only 1 hospital => monopsony
DefineAnd only 1 wage paid to all nurses
MFC = ∆TFC/∆LTFC = WL
SL
w
L1 2 3
20,00015,000
10,000
L W TFC MFC 1 10K 10K 10K 2 15K 30K 20K 3 20K 60K 40K 4 25K 100K 75K
MFC
SL
DL
W
QS QD
MFC > SL…Why?Firm sets MFC = DL….why?
And pays lowest wage possible given by SL.Appears to be a shortageBut firms are profit-maximizers