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