To understand the economic problems and choices facing hospitals, it is useful to regard them as firms, and apply to them the general principles of microeconomics which shape the environments of all firms. However, hospitals are firms of a specialized type not simply in terms of the services they provide, but in terms of how and by whom those services are provided. Hospitals are also institutions (or firms) in transition. To understand how they work (or fail to work) today, we must examine how they worked in the not to distant past.
Until the last decade or two, most hospitals were nonprofit enterprises. Thus, they were not products of strict business entrepreneurship in the usual sense of a person or persons setting up a business to provide a good or service and earn a profit by doing so. Rather, hospitals were established by what might be called "philanthropic entrepreneurship," in which a person or persons persuaded donors, or a community, that a facility was worth supporting. These philanthropic entrepreneurs obtained a variety of benefits in turn for their efforts. Hospital operators and investors received some material rewards honaria for board members, buildings named after major donors, but even more important, perhaps, in the reward structure of philanthropic entrepreneurship (and the "philanthropic capitalism" of donors) was community esteem and the "warm glow" of satisfaction (Andreoni, 1989: 1448), a satisfaction not fundamentally different in economic terms from the satisfaction felt by the buyer of a conventional good.
Nevertheless, the nonprofit hospital had many of the characteristics of a business. Payments by patients would not serve to provide a profit, but would tend to lessen the drain on endowments, paying most operating expenses and leaving the endowments largely for capital projects. Thus, a hospital that could fill its beds would be more economically viable than one with a ...