Economic Problems Facing Hospitals

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 nottodistant 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 d

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demand curve for hospital support services. Traditional physicians were selfemployed professionals, individual forprofit entrepreneurs. But, since they did not pay for the use of hospital staff and facilities (these being billed to the patient) cost was a concern only the degree that they might lose patients due to outrageous hospital billings. This "reputation effect" that is, a reputation for overcharging is the major check on the capability of physicians and other experts to induce demand for their services among clients, such as patients, who are highly dependent on the experts' advice (Dranove, 1988: 28990). Short of the negative reputation effect, however, the physician was under minimal cost constraints. Use of the hospital was not rationed among physicians by cost, but by a process akin to club membership. "Costcutting" was thus not an individual physician's chief concern in having a patient admitted to a given hospital; rather his concern was with the degree to which the hospital would facilitate his work. The physician wanted access to a full range of support and specialized services, and would use the hospital that provided them. So long as charges were not "outrageous" (in patients' perception

Category: Economics - E