NonProfit Firm

1. NonProfit Firm Introduction to Nonprofits Why Nonprofit are prevalent in the health care Models of Nonprofit Hospital Behavior

2. An introduction to Nonprofits • Nonprofit as providers of unmet demands for public good • Market Failure: ExternalitiesFree markets tend to underproduce goods for which there exist significant external benefits. E.g. Purchase of vaccination. • Market Failure: Public goodA public good in economics is defined as a good that is both nonexcludable and nonrival. Nonexcludable means that people cannot be economically excluded from consumption good even if they refuse to pay for it. Nonrival means that one person can consume the goods without depleting. Public goods are often provided by government. Private enterprise may tend to provide too little because of free riders. * Hospital services, nursing home service are probably not pure private goods. The Weisbrod analysis will be applicable in principle to any such service that provide external benefits to community at large.

3. Why Nonprofit are prevalent in the health care • Arrow (1963) suggested that the prevalence of nonprofits is due to the uncertainty of identifying quality of care. • Hansmann (1980) insisted that nonprofit sectors help to repair the problem of contract failure that occur when the quantity or quality of output is difficult to observe => Asymmetry Information

4. The role of physicians in the hospital industry • Interest Group (Bays, 1983)In the nineteenth century, US hospitals were charitable institutions where physicians largely donated their time. With rapid population growth and hospitals expansion at the same period, for-profit hospitals were generally small.As medical technology advanced, hospital became the workshops of doctors. By controlling hospital admitting privileges, organized physicians gained a degree of market power. Under this theory, physicians prefer nonprofit hospitals because they have greater power within them. In enhance their own income, physicians can order hospitals services complementary to their own services, perhaps well past the extent that would be profitable to the hospitals.

5. Financial Matters and the Nonprofit • [disadvantages] Lacking the ability to distribute net revenue, the nonprofit do not issue equity stock and thus lack this advantage for raising capital. • [advantages] It is exempt from corporate, property, and sales taxes and its bonds are generally tax-exempt. Responsiveness and loyalty generated by the consumer’s response to nonprofit under the contract failure situation. Finally, it is more likely to attract donations than is the for-profit.

6. Models of Nonprofit hospital behavior • The Quality-Quantity Nonprofit TheoryObjective of the hospital decision makers(1) Utility-maximizationNewhouse (1970): the hospital’s objective is to maximize the utility of the decision makers.Problem: who are the decision makers? Nonprofits tend to have three parties with considerable decision-making authority: The trustees are nominally in charge of hospitals. The trustees’ decision-making agent is the hospital administrator. The arbiters of medical decision making are the physician staff.(2) Profit-maximization

7. (1) Utility-maximization • The Utility functionIn Newhouse’s model, the hospital’s preferences are defined over quantity and quality of output. Hospitals select a combination of quantity and quality that maximizes utility • The Quantity-Quality FrontierIn general, there are a trade-off relationship along quantity-quality Frontier. The frontier also illustrates two specials cases: The hospital-quantity maximization proposed by Long (1964)(Point B in Figure 13-3) and the hospital quality maximization constructed by Lee (1971)(Point C) • The general case illustrates that the constrained utility maximization point occurs at a point of tangency between the frontier and the highest indifference curve attainable. (Point A)

8. (2) Profit-maximization • Maximizing Net Revenue (NR) per Physician (M)=> Max NR/MThe net revenue is the sum of the revenue less factor payments to nonphysician labor and payments to capital. An increase in the number of physicians, M, initially increases revenue per physician. Eventually, revenue per physician must fall because the percent increase in revenue (numerator) will be smaller than the percent change in number of physicians (denominator)Figure 13-4For physicians who are on the staff, the optimal staff size will be M*. In contrast, if the physician has a open staff, physicians are free to enter as long as their resulting average income, N, equals or exceeds their supply prices. Thus, the open-staff equilibrium occurs at point C.

9. The Harris Model • Compared to the previous case of Physicians’ cooperative, Harris proposes that the hospital’s internal organization is really two separate parts in hospital’s structure: the trustee-administrator group that serves as the supplier of inputs, and the physician staffs that serves as the demanders on behalf of their patient. However, patients are heavily insures. Moreover, the unusual relationship that requires the physician to make noneconomic decisions on the patient’s behalf. This makes market-like negotiations between supplier and demander impossible. => The hospital, according to Harris, solves the problem with a variety of nonprice related decision rules.