Some Problems of Pricing and Resource Allocation in a Non-Profit Industry- The Hospitals

Abstract

W THAT can be said of the implications of an industry in which the market constraints of competition and profit motivation are either absent or extremely weak, and there is no effective substitute device for stimulating efficiency? This paper considers certain relationships between prices, costs, capacity utilization, and resource allocation in such an industry hospitals. This is not a complete analysis of the hospital industry. Rather, it is an examination of but two aspects: the structure of room prices and the instability of demand. Under competitive conditions, prices in an industry consisting of profit-maximizing firms will equal marginal private costs in the short run and also average full costs in the long run. If private costs equal social-opportunity costs, the industry behavior will be optimal in the Pareto sense, given the existing resources, state of technology, and distribution of income. But hospitals constitute an industry in which competition is constrained by financial and other barriers to entry and by institutional arrangements which limit access by a patient to the one or more hospitals with which his physician is associated.' It is also an industry in which support by taxation or private philanthropy diminishes financial pressures and in which public opinion opposes profit. It is my contention that the resulting insulation of the industry from some important market pressures permits pricing and investment practices to develop which appear to be non-optimal; I shall seek to demonstrate this. The implication of the argument is that, even if the hospital industry remains essentially non-profit, economic efficiency could be increased if hospitals would act more frequently as if they were profit maximizers. Greater attention to costs in general and to marginal costs in particular is required. The remainder of this paper is divided into two sections. The first analyzes the structure of effective hospital room rates; the second analyzes the instability of demand for hospital facilities and the resulting idle capacity. The sections are essentially independent, except that they deal with problems which continue to exist in part because of the protection of the hospital industry from efficiency inducing pressures.