al issues.
Overview of the Health Care Industry
Throughout most of the twentieth century, hospitals enjoyed the concept of the cost-plus system of reimbursement for medical expenses attendant to patient care either from the federal government or private insurers (Long et al., 1989). And then came a major change in the 1980s with the issuance of a new series of guidelines from the Federal Government, detailing the new system of "prospective payment systems" (PPS) (Long et al., 1989, 620). This system was designed to establish a mean rate across the country for different types of medical services as they were differentiated into Diagnosis-Related Groups (or DRG's). The impact of these two concepts -- PPS and its component DRG -- on the health care industry cannot be emphasized strongly enough. The result was nothing less than a complete restructuring, both philosophically and practically, of the entire hospital industry (Ellis et al., 1996; Cooper et. al., 1991; Eastaugh, 1985; 1990; 1997; Graf, Tanner, & Swinyard, 1993; Behner, Fogg, Fournier, Frankenbach, and Robertson, 1990). The philosophy behind PPS as related to DRG makes sound economic sense:
Under PPS, the product price is determined by the payer and, for each DRG, is designed to be reflective of the average cost to treat all patients within that DRG. In order for their hospital to survive, the hospital administrator will increasingly have to adopt the practices that facilitate cost minimizing, thereby maximizing the positive difference between reimbursement and cost (Long et al., 1989, 625).
Long's conclusion suggests one of the oldest maxims of structural economics, that of the utility theory. The basis of the utility theory is the concept of "constrained maximization" in which an institution, like hospitals, makes choices based on the act of attempted production maximization while being subjected to constraints -- increasing Federal and third-party r...