Hospitals in the Marketplace - PowerPoint Presentation

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Hospitals in the Marketplace

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25 September 2017

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Learning GoalsUnderstand how hospitals simultaneously seek to attract doctors to their medical staffs and patients to their hospitals.Master the model of market equilibrium for a not-for-profit hospital and discover how prices, quality, and quantity interact in these markets.Learn how the nature of competition has changed among hospitals as large buyers exert more power in the market.Digest the consequences of the large declines in demand for hospital services in recent decades and assess how industry entry and (mostly) exit occur.

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9.1 Hospitals and the Market for Medical StaffHospitals need doctors, but typically, doctors function independently, and thus hospitals must attract them.Recently hospitals have been acquiring more practices and thus gains from referrals to the hospital (even if the practices lose money).Typically hospitals provide doctors with facilities and services that make the doctor’s practice more profitable.Related to the “capture” models in Chapter 8.Some doctors are more attractive to the hospital, such as those who provide prestige or glamour or who are systematic moneymakers.Hospitals attract doctors by providing them with the ability to do things that they cannot do elsewhere.Specialized facilitiesGood lab work or assistanceDoctors also need hospitals, so the “bargain” between doctors and hospitals will vary by marketplace and individual characteristics.

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9.2 Hospitals and PatientsHospitals must attract patients.Some factors are similar to the attractions for doctors.Other factors such as food and quality of nursing staff may be important to patients.Price is rarely a factor for patients since most are covered by insurance.Some insurance plans pay only a portion of costs; some people are not insured.When Medicare and major insurance paid full dollar on hospital charges, competition centered on quality rather than price.Estimates of the price elasticity of demand for hospitals range from -1 to -4, although there is no consensus on the figure.Managed care plans should increase elasticity.Hospitals clearly do have some market power (ability to set price), confirming that something other than a perfectly competitive model is appropriate.

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9.3 A Model of Equilibrium Quantity and PriceAssume that the hospital utility function includes two characteristics—“quantity” (denoted N for number of days) and quality per day of care (denoted S for service). The hospital attempts to maximize the utility function U(N,

 S). The patients’ willingness to pay for the hospital service is represented by the inverse demand curve facing the hospital, P(N, S), where the willingness to pay P decreases with total quantity N (as is customary with demand curves) and increases with the quality of care S. The not-for-profit hospital also faces a break-even constraint specifying that revenue equals cost, [P

(N, S) × 

N = C(

N, 

S

)].

Assume that

patients respond to quality and price in the normal fashion.

Assume

that costs increase both with more quality

S

and more quantity

N

.

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9.3 A Model of Equilibrium Quantity and PriceAs in Figure 9.1, different demand curves exist for different levels of quality, and likewise, different qualities give different levels of cost.Figure 9.2 shows equilibrium combinations of quality and quantity.Where there are two intersections, the hospital would prefer one with more output and the same quality, all else equal.25 September 20176

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9.2 A Model of Equilibrium Quantity and PriceCan pick the best of all possible equilibrium points by using indifference curves.25 September 20177

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9.3 A Model of Equilibrium Quantity and PriceIn Figure 9.2, find the set of all possible equilibrium combinations of quality and quantity using these tools. First, pick any level of quality, for example, S1, and draw the corresponding average cost AC1 and demand curve D1

. The lower right of the two intersections is one possible equilibrium choice for the hospital. Now repeat that process for some other quality level, for example, S2, and again for S3, and all other possible combinations. The collection of points is the line EE, a continuous line so long as quality can vary continuously.

In general, this collection of points can slope either downward or upward, but only the downward-sloping portion should matter because on the upward-sloping portion of that set of points, the hospital could increase both N and

S

,

which (by our assumption) are both “goods” to the hospital decision maker.

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9.4 Insurance and Competition in the Hospital’s DecisionHow would various market events change the location and slope of the hospital’s demand curve? Other Hospitals’ Quality and Output ChangesConsider one specific hospital, St. Elsewhere.Suppose that another hospital in an area increases its quality.Demand for all services at St. Elsewhere will change.Its demand for higher quality services will fall because of the increase in quality elsewhere, and its demand for lower quality services that might increase (if prices rise at the other hospital)The EE curve will rotate counterclockwise (flatten), and the opportunity-possibilities frontier FF will also flatten, moving the optimal point to higher output and lower quality.

Entry of a new hospital would have similar results, depending on the quality of the hospital.25 September 20179

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9.4 Insurance and Competition in the Hospital’s DecisionOther Hospitals’ Quality and Output Changes, continuedEntry by other hospitals will cause some of St. Elsewhere’s patients to shift to the new entrant. The limiting case occurs when each hospital in the market has its demand curves at all levels of quality just touching their AC curves at one point—that is, just tangent to the AC curves. This will

occur on the left side of the AC curve, where AC is declining and the hospital’s capacity is underutilized. No further incentive for entry or exit.25 September 201710

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9.4 Insurance and Competition in the Hospital’s DecisionChanges to Patients’ Insurance CoverageWhat would happen if hospital insurance coverage changed for the patients in the market?Suppose that more patients suddenly became insured with standard “coinsurance”-type insurance. Demand curves become steeper and, in general, are further to the right than previously. This causes the

EE curve to shift outward to the right in Figure 9.2, causes the opportunity-possibilities frontier FF to expand outward in Figure 9.3, and leads to a higher equilibrium quality and quantity for the hospital. This would happen for all hospitals in the market because the expansion of insurance causes the demand curves for all hospitals to rotate outward. Thus better insurance not only increases the quantity of care demanded but also increases average quality, and hence average cost.25 September 2017

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9.5 Interaction of Doctors and Hospitals: “Goodies” for the DoctorConsider a doctor in a monopolistically competitive market with n physician-firms total, each initially with “typical” demand curves such as Dn and cost curves such as AC1 in Figure 9.5., and suppose that the hospital used some of its surplus in a way that reduced doctors’ AC curves.

If costs fall to AC3, existing doctors are no better off because entry will occur.If costs fall to AC2, there will be no entry, and doctors can begin to price monopolistically, setting MRn = MC2

, the marginal cost curve corresponding to AC2, and the price will be P

1.

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The price could rise or

fall

relative to the original price.

The key point is that the doctor receives a direct benefit because costs fall for the physician-firm and the optimal pricing response

must

make the physician-firm more profitable.

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9.6 Interaction of Doctors and Hospitals: Patients for the HospitalHospitals compete for doctors by doing things that make their physician-firms more profitable; doctors respond by admitting patients to the hospital, thereby shifting out the demand curve for the hospital, which allows the hospital to achieve more of its goals.The doctors who bring the patients to the hospital share somewhat in the fruits of the expansion, but not completely.This market seems to

have a stable equilibrium, in which hospitals compete for doctors (and hence patients) by providing cost-reducing “benefits” to its medical staff and doctors in return bring patients to the hospital. If doctors can move freely, and hospitals are open to new doctors, the equilibrium has the characteristics described here, with doctors getting some but not all of the possible economic returns that their patients provide for the hospital.In recent years, hospitals have begun to integrate their own services with those of physicians, commonly by purchasing physician groups, bringing doctors into more direct control of the hospital.Most commonly, the physician practices purchased by the hospital involve primary-care doctors (internal medicine, family practice, and general pediatrics) because a wide network of such practices can provide a strong referral base for the specialists in the hospital’s practice.

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9.7 Competition: “Old Style” Versus “New Style”The “old-style” hospital market in the U.S. as one in which most of the people going to the hospital had insurance that covered most of their expenses, so that demand curves were quite inelastic.Attracting patients was mostly the same as attracting doctors– providing quality.In markets like this, more competition drove up quality.An alternative type of insurance (and market equilibrium that would result) occurs if a large fraction of the insured population has incentives or administrative mechanisms that induce a high degree of cost consciousness on the part of patients.The first step came when Medicare (which at the time paid for about one-quarter of all hospital admissions) switched from a pay-dollar-for-dollar system to a very different system called the prospective payment system (PPS), which pays a flat amount to each hospital for a given category of admission.

During the same period, particularly in a few states, cost-conscious insurance spread through other sectors of the health care market as well. 25 September 201714

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9.7 Competition: “Old Style” Versus “New Style”The “old-style” hospital market in the U.S. as one in which most of the people going to the hospital had insurance that covered most of their expenses, so that demand curves were quite inelastic.Attracting patients was mostly the same as attracting doctors– providing quality.In markets like this, more competition drove up quality.An alternative type equilibrium occurs if a large fraction of the insured population has incentives or administrative mechanisms that induce a high degree of cost consciousness on the part of patients.The

first step came when Medicare (which at the time paid for about one-quarter of all hospital admissions) switched from a pay-dollar-for-dollar system to a very different system called the prospective payment system (PPS), which pays a flat amount to each hospital for a given category of admission. During the same period, particularly in a few states, cost-conscious insurance spread through other sectors of the health care market as well. 25 September 201715

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9.7 Competition: “Old Style” Versus “New Style”25 September 201716In California during the mid-1980s, the change in Medicare pricing coincided with a large increase in the market share of cost-conscious private health insurance as well as a shift to competitive bidding for the state’s Medicaid hospital business.Under the “old style,” competition increased costs.In the new-style era, the opposite appears to be happening more and more.

Melnick and Zwanziger, (1988), the role of competition appeared quite dramatically. In markets characterized by low competition, real hospital costs increased by only 1 percent in the 1983–1985 period. In markets characterized by high competition, real hospital costs decreased by more than 11 percent during this same period.

This competition through quality is termed a Medical Arms Race (MAR

), which should not be likely to occur with managed care, which reduces the ability of hospitals to compete in this way.Other studies have found that costs rise more rapidly in more concentrated (less competitive) markets.

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9.8 Entry and Exit: The Pivotal Role of For-Profit Hospitals25 September 201717If a community grows very rapidly or if demand grows for a service in some community, a for-profit hospital may be enter more rapidly than a not-for-profit.The same characteristic of rapid entry in the face of rising profits may cause for-profit firms to exit an industry faster than nonprofit firms when profitability

falls.It is difficult to characterize market responses to changes in demand fully in the hospital industry because some states forbid or limit the presence of for-profit hospitals, andgovernments sometimes subsidize or create hospitals where there are none.However, the growth of for-profit hospitals in regions of the country that grew rapidly over the past several decades lends credence to the idea that the for-profit response is faster than not-for-profits are capable of producing. The observation that for-profit hospitals have grown most rapidly in California, Florida, and Texas supports this idea because these areas have had rapidly growing populations and even more rapidly growing demand for hospital care.

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9.9 The Hospital in Labor Markets25 September 201718The demand for hospital services creates a derived demand for inputs, factor demand curves.Factor demand curves depend on the quality of service and the complexity of patient problems.Large hospitals demand both more staff and more highly trained staff.Hospitals compete for inputs, sometimes against other hospitals and sometimes in the general labor market.In the latter case, wages are determined in the broader market, and the supply curve facing the firm is perfectly elastic. For specialized labor, the hospital faces an upward-sloping supply curve.

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9.9 The Hospital in Labor Markets25 September 201719An increase in the demand for inputs will thus have different effects.An increase in the demand for general labor, such as janitors, has no impact on the wage rate.An increase in the demand for specialized services causes an increase in the wage rate.Anything that increases the demand for hospital services also increases the demand for inputs, potentially increasing input costs.The percentage of change in costs equals the percentage of change in the factor price multiplied by the cost share (%Δcost = %

Δwage × cost share).If nurses constitute half of the cost structure of a hospital and nurses’ wages rise by 10 percent, then hospital costs will rise by 5 percent. The increase is less if the hospital has the ability to substitute other forms of labor (or equipment, capital, or any other productive input) for nurses as the wage of nurses rises, but the first-order effect is as stated.

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9.10 Nursing “Shortages”25 September 201720A true “shortage” in an economic sense means that something is constricting the wage rate or the supply so that quantity demanded exceeds quantity supplied at the current wage rate.A shortage is a disequilibrium situation.In the U.S. market, there is no such restriction, and training programs for nurses are readily available.Thus the supply side of the nursing market can be considered competitive.Monopsonistic Markets

An alternative explanation is that hospitals have market power in the market for nurses.As shown in Figure 9.7 (next slide), the hospital faces an upward-sloping supply of nurses, and thus as the hospital hires more nurses, it drives up the wage.Thus the marginal factor cost (MFC) exceeds the wage of the last nurse, since the wages of all nurses rise.

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9.10 Nursing “Shortages”25 September 201721Monopsonistic Markets, continuedThus hospitals will hire up to the point where MFC = demand and pay a wage sufficient to attract the corresponding number of nurses.The gap between L1 and L2

represents the “shortages” of RNs confronting U.S. hospitals. U.S. data show a persistent rate of unfilled nursing positions, typically varying in recent years between 6 and 8 percent.

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9.10 Nursing “Shortages”25 September 201722Monopsonistic Markets, continuedFor monopsony power to have any meaning, the supply of nurses must be relatively inelastic. Sullivan (1989) estimated the one-year supply elasticity as only 1.3 and the three-year elasticity (longer run) as 3.8, evidence consistent with significant monopsony power. Staiger

et al. (2010) used changes in VA hospital staffing to estimate a very inelastic labor supply curve for nurses, hence considerable monopsony power. These estimates lend credence to the idea that nursing “shortages” may be a chronic condition in health care labor markets, since the conditions leading to monopsony behavior on the part of hospitals are not likely to change over time.In thinking about the long-run supply, the nursing profession has three pools from which to attract workers: new U.S. graduates, internationally trained graduates, and nurses coming out of retirement.

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9.10 Nursing “Shortages”25 September 201723Monopsonistic Markets, continuedFigure 9.8 shows the totals for U.S.-educated and foreign-educated RNs taking the National Council Licensure Examination (NCLEX) by year from 1983 to 2010.

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9.10 Nursing “Shortages”25 September 201724Monopsonistic Markets, continuedThe U.S. data especially show boom-and-bust cycles in terms of people’s interest in obtaining the RN license. Typical of markets where investment occurs when high returns exist in the market, but the investment takes time to mature, and when all of the investments mature, they can “oversupply” the market.

The other remarkable feature is the flatness of the test-taking trend (with embedded “sine-wave” cycles) from 1983 until about 2002, and then a steep climb, from about 70,000 (in 2002) to about 140,000 in 2010. This corresponds in time with the Nurse Reinvestment Act of 2002, which (among other things) gave strong financial incentives to enter the nursing profession, including scholarships and favorable loan-repayment programs. Some observers of the U.S. nursing market believe that the availability of appropriate faculty in nursing schools is the rate-limiting factor currently (Cullen, Ranji, and Salganicoff, 2011).