CAS EC 387 Introduction to Health Economics

L10: Hospitals

Department of Economics

Spring 2020

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Outline

Nonpro…t organizations (NPOs)

Hospitals and hospital models

How do outcomes, cost, and quality compare between di¤erent

ownership structures?

Long-term care

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Background I

Hospital in 12th century referred to church–run facility that cared for

the sick, disabled, and insane

Housed pilgrims, travelers, orphans, and the poor

Up until 19th century, hospitals were basically almshouses

Only those who had no homes stayed in hospitals - everyone else

preferred to remain at home

After World War II, hospitals began to witness increased technical

sophistication

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Background II

Pennsylvania Hospital …rst American hospital (1751) by support of

Benjamin Franklin

King George III chartered the New York hospital in 1771 to provide
care for the sick and poor, and instruction to Columbia Medical
School students

Massachusetts General Hospital built in 1821 at a cost of more than

$100, 000

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Modern Hospitals I

Rapid acceleration of cost-increasing technology

High share of total health spending led to hospitals as target for cost
containment

Hospitals very labor-intensive

Various payment sources

Hospitals are multi-product …rms:

lines include inpatient and outpatient services
skilled nursing facilities
home health services

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Modern Hospitals II

medical equipment sales

hospices
rural health clinics
physician o¢ ce rental

Majority of US hospitals are private not-for-pro…t organizations

(NPOs)

Large variety of types and organizational forms

High degree of complexity

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Not-for-pro…t Organizations

NPOs prevalent in healthcare, mostly hospitals

NPO 59%, for pro…ts 15%, government 26%

50% of mental health and substance abuse, 30% of nursing homes

Hospital spending about a third of total spending on personal health

services

Distinguishing characteristics:
Initial capital
No residual claimants (stock owners)
Liquidation
Tax treatment (donations, corporate income, property)
Board of trustees
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The Emergence of NPOs I

Market failures - externalities and public goods

Market provision of goods with externalities/public goods often not

optimal ! government intervention

Private/public aspect of charitable donations (impure altruism)

Government failure

Median voter theorem

Establish a nonpro…t …rm to account for residual demand

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The Emergence of NPOs II

NPOs dominant as response to uncertainty and incomplete markets

for risk (Arrow 1963)

FPs engage in behaviors that would not be demanded if consumers

were fully informed (Weisbrod 1988)

Antitrust policy

Attorney general scrutiny of hospital ownership conversions

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Issues and Concerns with NPOs I

What are their objectives?

Are the charitable assets properly valued?

Will transactions be subject to independent review?

Is the community at risk of losing valuable health care services?

Will the new entity continue to provide uncompensated care?

Will the proceeds of the sale be used to promote the original NPO
mission (which federal tax laws requires)?

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Issues and Concerns with NPOs II
Will members of the NPO board of directors or the FP purchaser
bene…t unfairly from the sale?

Will the trust be independent of the hospital?

Will hospital board members control the new charitable trust?

Ownership conversions occur in all directions (also occurring in health

insurance)

Will conversion from government or NPO result in higher hospital

prices and expenditures?

Will conversions result in decreases in quality of care at hospital?

Vested interests, some empirical evidence has been con‡icting

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Hospital Classi…cation I

Common organizational form

board of trustees
chief Administrator/CEO
sta¤ (some employed, some contracted)

Types
general/special
teaching
community
metropolitan/rural

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Hospital Classi…cation II
ownership
size
LOS

Physicians behave as
consumers
owners
managers (“rent-free workshop”)

Due to lower patient volume, market structure is changing -

consolidation and mergers

Hospitals forced to join MC networks, and/or reorganize to outpatient

care
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US Hospitals

Some 6, 000 hospitals in the US, employing 5 million people (half the
health sector)

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Utility Model of NPO Hospitals

Newhouse
NPOs utility depends on quantity q and quality s:

U = U (q, s )

Quantity - purpose

Quality - reputation, altruism, attracting good workers

Hospital trade-o¤ between quality and quantity

Early model treats hospital as black box

Graph

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Pauly-Redisch Hospital Model I

Physicians’cooperative

Collusion

Clear that physicians exercise important in‡uence on hospital

decision-making

Physicians control hospital and objective is to maximize net income

Similar to interest group models (e.g.,Harris)

"Pro…t maximization in disguise"

Trustees merely legitimize hospital actions

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Pauly-Redisch Hospital Model II

Open and closed sta¤ distinction

Consumer demand for hospitalization (includes payment to both

hospital and physician services):

p = p (q )

Hospital employs labor L and capital K and breaks even (just covers
cost):
ph q = wL + rK
Suppose M physicians, each with income yM (same for all doctors at
the hospital)

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Pauly-Redisch Hospital Model III
Income per doctor rewritten:

p (q )q wL rK
yM =
M
where:
p = ph + yM M
Hospital’s production function:

q = q (K , L, M )

Physicians seek to maximize:

p (q )q (K , L, M ) wL rK
yM =
M
Graph optimal number of physicians on sta¤

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Pauly-Redisch Hospital Model IV

Add supply schedules

Individual physicians on sta¤ have control over micro decisions

At best, hospital can determine stock of inputs, but physicians control

their use

How does it work in practice?

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Pauly-Redisch Hospital Model V
Cooperation easier with small sta¤:
each physician bears larger share of cost of his/her actions
departures from cooperative behavior more easily monitored by
colleagues
mutually agreeable decisions more likely to be reached

Medical sta¤ organization (committees, departments,etc.) may

reduce imperfect cooperation

Advantages of model:
it explains closed sta¢ ng arrangements
integrates hospital and physician behavior
shows why physicians like the not-for-pro…t organizational form

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Pauly-Redisch Hospital Model VI

explains some circumstances under which hospitals are not e¢ cient

Limitations:
applies to not-for-pro…t hospitals, but not well to government or
for-pro…t hospitals or to major teaching hospitals
does not incorporate complexities of hospital organizations
empirical evidence?

E¤ects of competition when comparing the two models

(Newhouse/Pauly-Redisch)

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