CHAPTER 6
THE HOSPITAL INDUSTRY
Econ3004/ Econ6039 Health Economics, 2023 Semester 2
Dr Yijuan Chen, Australian National University
Bhattacharya, Hyde and Tu – Health Economics
History of hospitals
 19th century hospitals could be fatal places to go to for
medical care:
 Most doctors made home visits to those who could
afford it, or held private practices.
 Hospitals were mainly for the very poor people.
 “Health care” were more like “death care”.
 But on the other hand, hospitals became an ideal field
for experimenting new medical procedures and new
medicines, which led to major breakthroughs in medical
science.
Bhattacharya, Hyde and Tu – Health Economics
History of hospitals
 Late 1800s innovations helped lift hospital
reputation
 Germ theory of disease
 Antiseptic techniques
 Anesthesia
 X-ray technology
Bhattacharya, Hyde and Tu – Health Economics
History of hospitals
 To meet the increasing demand for hospitals, in 1946,
the Hill-Burton Act increased the number of hospitals in
the US
 Congress gave monies for building hospitals. Any hospital
receiving money had to provide free/low cost care to the
poor
 Result: more hospitals and more hospital beds
Bhattacharya, Hyde and Tu – Health Economics
History of hospitals
 But the number of hospitals and the number of
hospital beds reached their peak in 1974 and then
started to go down
Bhattacharya, Hyde and Tu – Health Economics
History of hospitals
 The decrease of the numbers of hospitals and hospital beds
are attributed to two reasons:
 Technology advances have reduced recovery times
 Insurer increasingly design hospital payment to incentive
shorter hospital stays
Bhattacharya, Hyde and Tu – Health Economics
History of hospitals
 In 1984, the US Medicare introduced the Diagnosis-related
Group (DRG) payment system.
 Prior to DRG, hospitals were paid on a fee-for-service basis.
 Under the DRG, hospitals received a fixed fee that only
depends on the patient’s diagnosis.
Bhattacharya, Hyde and Tu – Health Economics
History of hospitals
 Hospitals’ response to DRG?
 If revenue cannot be increased, then reduce the cost, and
thus:
 Change some inpatients to outpatients
 Reduce the hospital stay of inpatients.
 This is another example that hospitals and physicians have
the incentive to improve their financial wellbeing.
THE RELATIONSHIP BETWEEN HOSPITALS AND
PHYSICIANS
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Different modes of hospital-physician relationships
 “Physician uses hospital as his “workbench”
(Majority in US)
 A physician is not directly employed by hospital
 The physician runs his own private practices, but can
refer his (sickest) patients to the hospital and provide
treatment there using the hospital’s resources, including
medical equipment and medical staff.
 Insurance company pays the physician and the hospital.
 Harris (1977) argues that a hospital consists of two
separate economic entities: the physicians, and the
admin staff including nurses, clerks, and executives.
Bhattacharya, Hyde and Tu – Health Economics
Different modes of hospital-physician relationships
 Direct employees
 In the UK, most physicians are direct employees of the
National Health System, which runs most of the nation’s
hospitals.
 In the US, since the mid-1990s, there has been an increasing
amount of physicians who specialize exclusively in hospitals,
known as “hospitalists”.
 Physician-owned hospitals (Japan; US)
Bhattacharya, Hyde and Tu – Health Economics
Different modes of hospital-physician relationships
 The physician’s incentive and the hospital’s are not fully
aligned
 In the work-bench model, the physician has the
incentive to over-use the hospital’s resources in order to
improve the treatment outcomes. This drives up the
health-care costs.
Bhattacharya, Hyde and Tu – Health Economics
Different modes of hospital-physician relationships
 In the direct-employee mode,
 the hospital can better control the physician’s usage of the
hospital’s resources. Also there is positive externality and
spill-over of knowledge among the pool of hospitalists.
 But because a big proportion of the physician’s payment is
fixed salary, and he may have less incentive than self-
employed physicians to treat patients.
 At physician-owned hospitals, physicians may have to
spend more time at the admin work, and thus less time
in treating patients.
Bhattacharya, Hyde and Tu – Health Economics
 There is a strong correlation between patient volume
and treatment outcome.
Positive volume-outcome correlation
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 Learning-by-doing hypothesis
 High volume leads to good outcomes
 Selective-referral hypothesis
 Good outcomes leads to high volume
Positive volume-outcome correlation
Bhattacharya, Hyde and Tu – Health Economics
Does hospital experience or physician experience
matter?
 McGrath et al. (2000) compare outcomes of Medicare
patients undergoing percutaneous coronary intervention
(PCI) provided by low-volume and high-volume hospitals /
physicians.
 Patients experience significantly worse outcomes when
served by low-volume providers
 But the volume-outcome relation is more significant at the
hospital level than at the physician level.
 The finding suggests that the teamwork (coordination and
collaboration) of the medical workers in the hospital benefits
more from patient volume than the individual physicians.
THE RELATIONSHIP BETWEEN HOSPITALS AND
HOSPITALS
Bhattacharya, Hyde and Tu – Health Economics
Differentiated product oligopoly
 Hospital industry is a differentiated product oligopoly
 Strict barriers to entry
 Building hospitals entails high investment costs in many
dimensions, including acquiring land, construction,
technology, recruiting medical and administrative staff, and
it often requires government approvals.
 The entry barrier results in few hospitals (oligopoly).
 Hospitals differ in their strength, including technology,
experience, and physician ability in different specialties.
Thus services provided by the hospitals are not perfect
substitutes (differentiated products)
Bhattacharya, Hyde and Tu – Health Economics
Differentiated product oligopoly
 Herfindahl-Hirschman Index as a measure of market
concentration
 HHI = ∑ si2 , with si = market share for a firm
 HHI closer to 1 means few firms in the market (highly
concentrated)
 HHI closer to 0 means a large number of firms in the market.
 The US Department of Justice and the Federal Trade Commission
label a market as “concentrated” if its HHI is greater than 0.18,
and “highly concentrated” if greater than 0.25.
 Gaynor and Town (2013) show that in 2006 the HHI for
the hospital market in the average American
metropolitan area was 0.33.
Bhattacharya, Hyde and Tu – Health Economics
Limited competition
Not just due to barriers to entry. Also:
 Because of insurance, prices not transparent
 Adverse selection and Moral hazard in multiple
sides.
 Emergency nature of health care means that
patients are unable to search for the “best” and
“cheapest” hospital
 On top of these, there are strong government
regulations
Bhattacharya, Hyde and Tu – Health Economics
Limited competition
We examine four types of competition between hospitals:
 with homogenous products
 with exogenously differentiated products
 with endogenous horizontal product differentiation
 with endogenous vertical product differentiation
Bhattacharya, Hyde and Tu – Health Economics
For-profit and nonprofit hospitals
US hospital industry has both for-profit and nonprofit
hospitals
 Majority of hospitals are nonprofit
 2009: 75% of private hospitals organized as nonprofits
 Benefits of nonprofit status:
 Exempt from taxes
 Donors receive a tax deduction
 Costs of nonprofit status:
 Cannot sell stock
 Cannot distribute profits to owners
 Restricted to certain charitable activities
Bhattacharya, Hyde and Tu – Health Economics
Why do nonprofits exist?
Theories for nonprofit existence
1. Altruistic-motive theory
 Some entrepreneurs prefer altruism over profits
2. Government-failure theory
 Politics ineffectively help those in need
3. Asymmetric information
 Donors trust nonprofits more with money
4. Nonprofits are for-profits in disguise
 “profits” are distributed as higher wages or non-monetary benefits
 Mixed study results
Bhattacharya, Hyde and Tu – Health Economics
Public and private hospitals in Australia
 In Australia, hospital services are provided by
both public and private hospitals.
 The state and territory governments largely own
and manage public hospitals.
 Public acute hospitals mainly provide ‘acute care’ for
short periods, although some provide longer-term care,
such as for some types of rehabilitation.
 Public psychiatric hospitals specialise in the care of
people with mental health problems, sometimes for long
periods.
Bhattacharya, Hyde and Tu – Health Economics
Public and private hospitals in Australia
 Private hospitals are mainly owned and managed by
private organisations—either for-profit companies, or
not-for-profit non-government organisations.
 They include day hospitals that provide services on a day-only
basis, and hospitals that provide overnight care.
Bhattacharya, Hyde and Tu – Health Economics
Public and private hospitals in Australia
Bhattacharya, Hyde and Tu – Health Economics
Public and private hospitals in Australia
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Public and private hospitals in Australia
Bhattacharya, Hyde and Tu – Health Economics
Public and private hospitals in Australia
THE RELATIONSHIP BETWEEN HOSPITALS AND PAYERS
Bhattacharya, Hyde and Tu – Health Economics
Prices vary greatly across hospitals
Bhattacharya, Hyde and Tu – Health Economics
Prices vary greatly across hospitals
 But in actuality, buyers (both insurers and patients) rarely
pay the chargemaster price. Instead, hospitals and insurers
-- both private and public -- periodically negotiate rates
 Rates vary with relative bargaining power of hospital & insurer
 The same hospital may receive different rates from different insurer
Bhattacharya, Hyde and Tu – Health Economics
Who pays for uncompensated care?
Uncompensated care: hospital charges not covered by out-of-pocket
payments, public insurance, or private insurance.
Last-resort laws mandate that hospitals treat all patients who enter their
emergency rooms.
What happens when a patient lacks the resources and insurance to pay
for this care?
Bhattacharya, Hyde and Tu – Health Economics
Who pays for uncompensated care?
 Ultimately, someone has to pay for uncompensated care.
 Unpaid hospital care is paid for through cost-shifting
 Rich patients pay for poor patients’ care (cross-subsidization)
 In the US, reimbursement rates much higher for private insurers than for
Medicaid or Medicare
Bhattacharya, Hyde and Tu – Health Economics
Who pays for uncompensated care?