Health care is one of the fastest rising expenses faced by American families. Every year, health care expenses rise faster than either consumers' incomes or the general rate of inflation. It would seem, then, that health care providers of which hospitals are the most conspicuous institutional component would be a highly lucrative enterprise. In fact, however, hospitals have found the late 1980s to be a difficult period, with conditions improving only slightly at the beginning of the 1990s.
Hospitals typically earn a margin over expenses of about one percent on their general patient population. Over a third of hospital beds are empty at any one time (Hamilton, 1989). While the rising population of the aged means an increasing supply of patients, a greater proportion of these are low revenue Medicare cases, rather than the more profitable private payer patients (Fritz, 1989).
In response to their problems, hospitals have tightened management (Siler, 1990), aggressively marketed specialized services such as drug addiction treatment, and even branched out into nonhospital services, e.g., running a catering business out of the food service operation (Paris, 1989). Nevertheless, the hospital business remains a tough one, confronted by powerful and conflicting competitive and regulatory pressures (Garland and Smart, 1989).
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, m...