CHAPTER 6THE HOSPITAL INDUSTRYBhattacharya, Hy.docx

CHAPTER 6
THE HOSPITAL INDUSTRY
Bhattacharya, Hyde and Tu – Health Economics
History of hospitals19th century hospitals could be fatal places
to go to for medical care
Higher mortality rates in the hospital than at homeLate 1800s
innovations helped lift hospital reputationGerm theory of
diseaseAntiseptic techniquesAnesthesiaX-ray
technologyIncreased demand for hospital surgeries led to
increased need for more hospital resources
History of hospitalsIn 1946, the Hill-Burton Act increased the
number of hospitals in the US
Congress gave monies for building hospitalsAny hospital
receiving money had to provide free/low cost care to the
poorResult: more hospitals and more hospital beds
History of hospitalsTechnology advances have reduced recovery
timesInsurer increasingly design hospital payment to incentive

shorter hospital stays
Trend towardIncreased outpatient visitsDecreased length of stay
For example, the Diagnostic Resource Groups (DRG)
reimbursement method used by U.S. Medicare pays hospitals
based on the patient’s initial diagnosis and does not depend on
the number of days the patient actually spends in the hospital.
*
Ch 6: The Hospital Industry
THE RELATIONSHIP BETWEEN HOSPITALS AND
PHYSICIANS
*
Different modes of hospital-physician
relationshipsModes:“Physicians’ workbench” (Majority in
US)Physicians not directly employed by hospitalDirect
employees (UK NHS; US “hospitalists”)Physician-owned
hospitals (Japan; US)
Tradeoffs between the different modes:
Physician loyalty to hospital or the patient?
Doctors without connection to the hospital may overuse
hospital resources

Surgical mortality rates decrease with increased hospital volume
Learning-by-doing hypothesisHigh volume leads to good
outcomesSelective-referral hypothesisGood outcomes leads to
high volume
Positive volume-outcome correlation
*
Does hospital experience or physician experience matter?Should
you prefer having your surgery with an experienced physician
or in an experienced hospital?
McGrath et al. (2000) findHospitals with more surgical
experience have fewer complications than physicians with high
experience
Finding makes sense if teams of medical workers collaborate on
surgeries, so individual physician experience less impactful
Compare outcomes of Medicare patients undergoing surgery to
unclog coronary arteries (PCI)
Experience of the hospital is more important than the attending
surgeon’s experience

*
Ch 6: The hospital industry
THE RELATIONSHIP BETWEEN HOSPITALS AND
HOSPITALS
*
Differentiated product oligopolyHospital industry is a
differentiated product oligopolyStrict barriers to
entryBuildings, technology, staff, administration, etc.Few firms
(oligopoly)Services provided by each firm are not perfect
substitutes (differentiated products)Herfindahl-Hirschman
IndexHHI = ∑ si2si = market share for a firmIf HHI closer to 1
means few firms in the market (highly concentrated)If HHI
closer to 0 means a large number of firms in the market
*
Limited competition
Not just due to barriers to entry. Also:
Because of insurance, Prices not transparentMoral hazard for
insured patients Government often sets pricesEmergency nature
of health care means that patients are unable to search for the

“best” and “cheapest” hospital
*
Is hospital competition good for patients?
Typically, competition improves quality and lowers prices.
BUT Ubiquity of insurance hinders price competition Patients
are typically referred to hospitals by physicians, so hospitals
compete for physiciansMedical arms race hypothesis: greater
competition among hospitals for physicians can result in
redundancy in and overconsumption of medical technologies.
This can actually increase costs without improving quality Lots
of empirical research about the effect of hospital competition on
patient outcomes: mixed findings and different policy
implications.
For-profit and nonprofit hospitals
US hospital industry has both for-profit and nonprofit
hospitalsMajority of hospitals are nonprofit 2009: 75% of
private hospitals organized as nonprofits
Benefits of nonprofit status:Exempt from taxesDonors receive a
tax deduction
Costs of nonprofit status:Cannot sell stockCannot distribute
profits to ownersRestricted to certain charitable activities

Why do nonprofits exist?
Theories for nonprofit existence
Altruistic-motive theorySome entrepreneurs prefer altruism over
profits
Government-failure theoryPolitics ineffectively help those in
need
Asymmetric informationDonors trust nonprofits more with
money
Nonprofits are for-profits in disguise“profits” are distributed as
higher wages or non-monetary benefitsMixed study results
Ch 6: The hospital industry
THE RELATIONSHIP BETWEEN HOSPITALS AND PAYERS
Prices vary greatly across hospitalsAccording to public price
lists or “chargemasters”, the cost of a chest x-ray in 2004
ranged between $120 and $1,519 across seven California
hospitalsTremendous variability!!But in actuality, buyers (both
insurers and patients) rarely pay the chargemaster price
Instead, hospitals and insurers -- both private and public --
periodically negotiate ratesRates vary with relative bargaining
power of hospital & insurerThe same hospital may receive
different rates from different insurer
*

Who pays for uncompensated care?
Ultimately, someone has to pay for uncompensated care.
Unpaid hospital care is paid for through cost-shiftingRich
patients pay for poor patients’ care (cross-subsidization)In the
US, reimbursement rates much higher for private insurers than
for Medicaid or Medicare
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?
*
CHAPTER 5
THE PHYSICIAN LABOR MARKET
Outline
The training of physiciansMedical school & residencyReturns to
medical trainingWork hoursBarriers to entryPhysician
agencyPhysician-induced demandDiscrimination

The training of physicians
Medical schoolEntry into med school is competitive and
selective worldwideIn the US, average 50% of applicants are
accepted into at least one schoolLength of medical school varies
across countryUS & Canada applicants must first get a
bachelor’s degreeEuropean applicants go directly from high
schoolMedical school can be super-expensive US: $140k --
$225k for four yearsEuropean medical training often heavily
subsidized
ResidencyIn addition to classroom work, physicians-in-training
must also gain hospital experienceResidency is a period of on-
the-job training following medical school
New residents lack experience, and when new residents arrive at
a hospital, empirical evidence that medical errors go up“July
effect” in the US“August killing season” in the UK
Physician work-hoursWork hoursOver 60 hours a weekOn call
residents could work up to 30 consecutive hours
In 2003, implementation to limit number of hours/week for US
doctorsNo more than 80 hours a weekNo change in patient
mortalityMany residents still work over 80 hours a week, but
report only 80 hours

Work-hour tradeoffsLonger work-hoursFatigue may impair
physicians’ cognitive abilities and in turn may affect patient
health
Shorter work-hoursRequires more hand-offs by physicians and
thus greater chance for error
Empirical question which effect dominates
Shorter hours leads to fewer errors Randomized experiment at
Brigham and Woman’s ICU at Harvard (2004)2 groups:
traditional hours (80 hours/week) & short work week (60
hours/week)
Traditional hour groupCommitted 36% more serious medical
errors21% more medication errors5.6 times more diagnostic
errorsSenior physicians intercepted most serious errors
Returns to medical training
Returns to medical trainingUnlike most occupations, returns to
medical training are very back-loadedMedical school &
residency expensive in direct costs and opportunity costsSo
those who choose being physician are patient enough to value
future returns

Net present valueNet present value is a way of calculating value
of all future streams of income (from today’s perspective)
Discount factor δ is a measure of how much less an individual
values future income over present incomeδ lies between 0 and
1; small if impatient and large if patientThose with high δ have
high NPV from being a physicianThose with low δ have low
NPV (and maybe even negative NPV)
Discount factorAnother way of expressing discount factor is:
Where r is the discount rate, analogous to the market interest
rate that would make a person with discount factor δ indifferent
between saving for tomorrow and spending todayEx: δ = 0.90
corresponds with r = 0.11 Very patient have high discount
factors δ and low discount rates r
δ = 1/(1+r)
Internal rate of return (IRR)Consider two possible career
choices P and C with incomes paths Ip and IcInternal rate of
return r* is the discount rate which equalizes the NPV of both
careers (or the difference between NPV(p) – NPV(c) = 0 )
Someone with IRR of r* values career P and career C exactly
equally

Internal rate of returnIRR in medicine is typically between 11%
and 14%! Significantly higher than market interest rateThis is
true for dentists and lawyers tooIRR may be even higher for
medical specialists like neurosurgeons and immunologists
The fact that the IRR has stayed high is curiousSuggests that
being a physician is highly lucrativeWhy hasn’t that attracted
more physicians, which would have pushed the IRR back down
to market levels?
Barriers to entry
Barriers to entry may explain the high IRRIn 19th century,
becoming a doctor was simpleAnyone could do it, no regulation
about training
American Medical Association (1847)Pre-req’s for medical
school4 years medical schoolRequire doctors to have a license
to practice1910 Flexner Report helped shut down low-quality
med schools
Result: less med schools and less med students
More barriers to entryCaps on medical school class sizeDoctors
need license to practice on their ownInternational med
graduates Long and arduous process to practice in the USNurses
and Physician AssistantsLimited in scope of practiceAlternative
medicineChiropractors, acupuncturists, etc. need licensure too

Tradeoffs from barriers to entryBecause of barriers to entry,
consumers have to pay above the competitive pricePhysicians
therefore earn monopoly rentsDef. wages above the competitive
price due to artificial constraint of the market
Barriers to entry ensure that physicians are qualified
Physician agents
Physicians as agentsPatients trust physicians to act as perfect
agents for their healthDoctors’ foremost concern should be
patients’ well-beingNot their own financial status or reputation
Are doctors always perfect agents for their patients?
Physician-induced demand (PID)Information asymmetry
between doctor and patientPatients cannot assess whether an
extra test or procedure ordered by doctor is necessary
Financial incentive for doctors to prescribe more services than
needed
Empirical evidence that when reimbursement rates for various
procedures change, doctors prescription practices also change

Defensive medicineDefensive medicineOverutilization of
testing and servicesProtects against malpractice lawsuits
Doctors fearful of lawsuit may overprescribe (and overcharge)
for only marginally-useful procedures
Mello et al. (2010) estimate that medical liability system in the
US costs $55.6 billion annually
Racial discriminationTypes of discriminationTaste-
basedPreferential treatment for certain groups of
patientsConscious or unconsciousStatisticalStereotypes on
biology or behavioral tendenciesDiscrimination can be efficient
or inefficientSome discrimination may harm patients, but others
may benefit them
Evidence of discriminationAudit study (Shulman et al.
1999)Fictional patient historiesBlack and white actorsPatients
told doctors same script, background, and hand motionsOnly
difference was the race of “patient”/actorResultsPhysicians less
likely to recommend standard treatment if patient was
blackTaste-based or statistical discrimination?Efficient of
inefficient discrimination?
Efficient discriminationTaste-based is always
inefficientStatistical may be efficientEfficient if medical
evidence to treat racial groups differentlyEx: optimal
hypertension treatment is different for blacks than for whites

ConclusionPhysician supply highly regulatedLeads to a shortage
of doctorsHard for other health care providers to fill the void
Investment returns to being a doctor and specializing is very
high
Physicians are not always perfect agents of careOverutilization
of carePhysician-induced demand and defensive medicineRacial
discrimination

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