Download Theories of hospitals as firms

Economics of health care
Topic 10. Health care providers as firms
1. Theory of the firm: profit maximisation,
price, quantity and costs.
Perfect competition:
 industry equilibrium
 Each firm is a ‘price taker’
 MR = the addition to revenue resulting
from a 1 unit increase in quantity sold.
 MR the same over all Qs
 Profit maximising quantity is where MC =
MR.
Imperfect competition:
 Each firm faces a downward sloping
demand curve
 MR schedule also downward sloping
 Profit maximising quantity is where MC =
MR.
 The price which will be charged at that
quantity will be ‘read off’ the demand curve
2. Why are hospitals different?
 Services are produced ‘at the point of
demand’; cannot be stored; poorly
substitutable between patients.
 In contrast to other firms, decisionmaking highly decentralised; individual
workers (Drs) have discretion over
resource use.
 Provision is dominated by not-for-profit
(nfp) firms
 profit maximisation may not be the
appropriate maximand.
3. Why do not-for-profit firms exist?
Weisbrod (1975): satisfies demands for goods
in which markets fail (externalities, public
goods)
Hansmann (1980): a response to contract
failure (where quantity/quality of output not
easily observed by the purchaser)
Bays (1980): interest group theory.
(for a useful review of each, see Folland
Goodman and Stano).
Theories of hospitals as firms
a. ‘traditional’ theory of the firm: profit
maximisation
b. Managerial theories of the firm: hospital
pursues other (or multiple) objectives
c. Behavioural theories: internal bargaining
between rival groups within the hospital, rather
than the specification of an objective function.
(a) a priori not applicable to nfp
(b) & (c) could apply to fp and nfp
4. Maximisation of quantity (Baumol 1967)
P
MC
AC
D
Q1
MR
Q2
Quantity of
patient days
 Profit max = Q1
 Quantity max = Q2 (where AC =
Average revenue) subject to a
‘breakeven’ profit constraint.
 Q is higher than profit maximisation
would predict
 and prices are lower
5. Maximisation of quality (Lee 1971)
 Managers of n-f-p maximise utility by
attempting to enhance the status/prestige
of their institutions.
 Managerial utility = f(salary, security,
power, status)
 Status positively related to the range of
services available and the extent to which
expensive and highly specialised
equipment and doctors are available.
 Suggests higher costs
 May explain duplication of resources and
overspecialisation?
6. Maximisation of quantity & quality
(Feldstein 1971; Newhouse 1970)
 Managers choose a combination of quality
and quantity that maximises their utility.
 Given a trade-off between quantity and
quality, managers will seek an optimal
combination of the two to produce.
P,
AC
AC3
AC2
AC1
Q1 Q3
Q2
quantity
quality
quantity
7. The managerial discretion model
(Williamson 1963)
 A model developed to explain the
behaviour of large firms not directly
managed by major shareholders
 Asymmetry of information between
shareholders and managers about the
performance of the firm.
 Managers will choose the profit
maximising output and price
 But will absorb profits through
discretionary expenditures (increasing
wages, staff, prestige; utility-enhacing)
8. The hospital as a physicians’
cooperative
Pauly and Redisch (1973)
The objective function is the maximisation of
pecuniary gain to the ‘decisive’ set of decision
makers. The hospital is de facto controlled
by the doctors, who operate the hospital so
as to maximise their net incomes.
NR/M = (P.Q – rK – wL)/M
Physicians’ income
max
Supply
Net average
revenue
Number of staff physicians
9. The hospital as ‘two firms in one’ (Harris
1977)
 separation of supply and demand
functions
 Drs, as agents for the patient, demand
services from other hospital staff (lab,
pharms, nurses, blood supply)
 Institutional constraints that arise through
the medical and ethical motives of Drs, as
opposed to their economic motives, that
are important.
“…it should be understood that the
organisation is set up to protect the Dr from
behaving as an economic man”
10. Research evidence
The performance of for-profits vs. not-forprofits
 theory suggests f-p hospitals will be more
efficient.
Evidence on this is of interest because…
 in the UK, greater use of the private
sector
 in the US, conversion from n-f-p to f-p
status
Sloan (1988) “Empirical evidence reveals
little or no difference in efficiency of
ownership type”.

implications for competition between f-p
and n-f-p?