317_L31, April 1, 2008, J. Schaafsma 1 Review of the Last Lecture began our discussion of hospitals as firms Reviewed some basic hospital trends post WWII Will look at two economic models of hospitals will discuss their efficiency implications

317_L31, April 1, 2008, J. Schaafsma 2 Two Models of the Not-for-Profit Hospital will look at two approaches to modeling the economic decision making process of not-for-profit hospitals: 1.Organic Model 2.Transactions models These are Bob Evans’ labels for these two types of models and are not universally used ///

317_L31, April 1, 2008, J. Schaafsma 3 Two Key Issues to be Addressed by the Not-for-Profit Hospital Models 1.Allocative Efficiency: -Admission rates per capita (too high, too low, just right?) - Service intensity per patient day (too high, too low, just right?) - length of stay (too short, too long, just right?) 2.Technical efficiency (is care produced at minimum cost given allocative efficiency?) ///

317_L31, April 1, 2008, J. Schaafsma 4 The Organic Model the NFP hospital is viewed as a single decision making entity  all are motivated by the same objective profit max is not the objective (since NFP)  what is?  commonly assumed  output maximization max output subject to a number of constraints: exogenous demand, production function, input markets basically the theory of the firm with output maximization replacing profit maximization why is it called the organic model?  all decision makers work together to achieve the common goal => output maximization///

317_L31, April 1, 2008, J. Schaafsma 5 Pricing in the Organic Model of the NFP Hospital In the absence of insurance: Prices set as low as possible to max output Price at Ave. Cost if firm must break even Price below average cost if the hospital is subsidized Cross subsidize: charge a high price where P elast of demand is low, use surplus to subsidize price where the P elast of demand is high => will assist with output maximization

317_L31, April 1, 2008, J. Schaafsma 6 Efficiency Implications of the Organic Model Technical Efficiency assured  follows from output maximization which requires elimination of all inefficiencies. Not much concern about Allocative Inefficiency since demand is exogenous ( no SID): 1. Admission rates: patients decide on the basis of HS, prices and income 2. Service intensity: patients decide on the basis of HS, prices and income Only concern  if P not equal to MC (likely won’t be since frequently a hospital has monopoly power)  MB not equal MC. with insurance => likely over cons’n (if no supply restriction)

317_L31, April 1, 2008, J. Schaafsma 7 How does the Organic Model Explain the Rapid Rise in Exp on Acute Care? original explanation  rapid rise in expenditures on acute care due to spread of hospital insurance (due to more favourable tax treatment of insurance premia) => with insurance more people could afford acute care  drove up demand for hospital care => drove up expenditure on acute care PROBLEM: don’t see a huge increase in the number of patient days per capita in the post war period as insurance coverage spread (i.e. before insurance coverage people were not staying out of hospitals due to a lack of insurance coverage) thus, spread of insurance didn’t drive up expenditure as a result of more hospitalizations per capita

317_L31, April 1, 2008, J. Schaafsma 8 Insurance and Rising Hospital Costs with more and better insurance coverage  hospitalization rates did rise somewhat => generated more revenue for hospitals  surpluses for NFP hospitals  surpluses used to acquire more equipment and services  service intensity   this was perceived as improved quality of care  people willing to pay the higher price to cover the increased cost (or to pay the higher premium for insuring for more resource intensive care) for FP hospitals => use some of the larger surplus to increase service intensity => perceived as improved quality => attract larger share of patients thus  spread of insurance believed to have driven up service intensity

317_L31, April 1, 2008, J. Schaafsma 9 Weaknesses of the Organic Model Demand for acute care is assumed to be exogenous, this is highly unlikely the assumption that all decision makers in an acute care hospital are motivated by output maximization is not realistic. Different interest groups in the hospital (Drs, nurses, admin, prov gov’t) may have different motives. For example, among doctors there may be rivalry for space and funding for their specialty; admin may want to fund a high profile program at the expense of less visible programs that are nevertheless very effective.

317_L31, April 1, 2008, J. Schaafsma 10 The 2 nd Model of the NFP Acute Care Hosp.: the Transactions Model this model recognizes that various groups with different objectives all have input into the management of the hospital sometimes their objectives coincide and sometimes they compete groups that have input into how a hospital is run: administration medical staff board of management nursing staff provincial ministry of health each has its own objectives and constraints “transactions model” since these groups give and take, i.e.“bargain” in pursuit of their main objectives. ///

317_L31, April 1, 2008, J. Schaafsma 11 Usefulness of the Transactions Model Approach probably the most realistic approach to modeling Canadian acute care hospitals however, extremely complex to model the interaction of multiple groups with coinciding and competing objectives subject to different constraints. Why even try to model the NFP acute care hospital?  1.Would like to understand what drives input and output decisions, can we be confident that efficiency is achieved? 2. need a model to predict how the hospital will respond to policy changes. ///

317_L31, April 1, 2008, J. Schaafsma 12 Implications of the Transaction Model does not provide a basis for being confident that the Canadian not-for-profit acute care hospital is technically efficient. provides no assurance that hospital admissions per capita per procedure is the correct rate (whose preferences determine admission rates?: prov gov’t?, Drs?, patients? lobby groups?) provides no assurance of appropriate service intensity (whose preferences determine service intensity?: prov gov’t?, Drs?, patients? lobby groups?) ///