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The Hospital Market, Part 2. Professor Vivian Ho Health Economics Fall 2007. Structure: Putting it all Together. Is the hospital market competitive, or not? Case Study : UNITED STATES OF AMERICA, Plaintiff, vs. MERCY HEALTH SERVICES and FINLEY TRI-STATES HEALTH GROUP, INC. Defendants.

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The Hospital Market, Part 2

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The Hospital Market, Part 2

Professor Vivian Ho

Health Economics

Fall 2007

Structure: Putting it all Together

Is the hospital market competitive, or not?

Case Study:


Filed October 17, 1995

  • Mercy and Finley: only 2 acute care hospitals in Dubuque, Iowa propose to merge.

  • Justice Department sues for preliminary injunction.


Dubuque population = 86,403

Mercy: 320 staffed beds, average daily census = 127.

Finley: 124 staffed beds, average daily census = 63.

competition - outside 70m radius, but within 100 m.

Madison, Wisconsin


Cedar Rapids


Freeport, Illinois

Iowa City, Iowa

  • Insurance coverage for Mercy/Finley patients

    • 50% Medicare/Medicaid

    • 25% Fee-for-service (traditional indemnity)

    • 25% Managed care (HMOs, PPOs)

      • Negotiated 15-30% hospital price discounts.

Justice Department case

1) Where do Dubuque patients go for hospital care?

88% inside (Mercy or Finley)

12% outside

2) Where are Mercy/Finley patients from?

76% inside (Dubuque)

24% outside

  • Dubuque the relevant geographic market, and merger constitutes a monopoly.


  • District court judge rejects Justice Department’s definition of geographic market as too narrow.

    • “The government continues to fail to look at the merger within the context of current market trends. All evidence is that there is a great deal of competition for health care dollars…”

  • “…if DRHS [merged entity] reacted in a noncompetitive manner, an HMO that could successfully induce Dubuque area residents to use alternative hospitals would be at a significant cost advantage.”

  • “There is also evidence that managed care entities can successfully induce Dubuque residents to use other regional hospitals for their inpatient needs.”

    Merger of Mercy and Finley would not/could not result in higher prices.

Case Study Conclusion

  • Even if only one hospital exists in a given geographic region, it may not be able to act as a monopolist

  • Ability of large, managed care buyers to shift patients can keep the market competitive.

Hospital Advertising

  • % of hospitals that advertise rose from 36% in 1995 to 50% in 1998.

  • We often see ads for local hospitals in newspapers and magazines.

  • Why?

Dorfman-Steiner model of advertising

  • The profit-maximizing amount of advertising occurs where:

  • If Ea equals .2, then 1% ↑ in advertising → .2% ↑ in demand.

  • And if EP equals 4, then Ea / EP 0.05

    • To max profits, hospital should spend 5% of total revenues on advertising.

Hospital will spend more on advertising when:

  • Ea is higher.

  • EP is lower.

    • ↑ advertising costs $.  But when demand is less elastic with respect to price, these costs can be passed onto the consumer.

    • Hospitals with greater market power will advertise more aggressively.

What type of advertising will hospitals use?

  • Advertising the availability of services that all hospitals have may ↑market size, but not your own patient base.

  • Hospitals will use advertising to differentiate their product.

    • Hospital rankings.

    • Luxury services.

Hospital Conduct

  • Large #s of sellers and low barriers to entry promote competition.

  • We expect increased competition to lead to:

    • Higher output and quality.

    • Lower price.

  • However, the hospital market has important differences.

    • Hospitals don’t necessarily maximize profits.

    • Government is a major payer

      • Prices not set competitively.

    • Consumer less likely to shop around.

      • Insurance and asymmetric info.

  • Is hospital market competition good or bad for consumers?

  • Markets with fewer hospitals may face higher prices.

    • But hospitals in more concentrated markets may be larger, and econ of scale may ¯ costs.

  • Look at price and quality effects of hospital mergers.

  • Data from Los Angeles in 1990-1993 suggests that hospital mergers would ↑ prices >5%. 

    • (Town & Vistnes 2001)

  • Hospitals that merged between 1989 and 1996 lowered their costs two years after consolidation relative to comparable hospitals that didn’t merge

    • (Dranove & Lindrooth 2003)

  • Even if hospitals lower costs, they may not pass price savings on to consumers.

    • Hospitals that merged in 1997-2001 raised their negotiated PPO prices relative to the median market price.

    • Other studies suggest that hospital consolidation does not improve the quality of care.

    • These results suggest that more competitive hospital markets favor consumers.

    Does Ownership Type Affect Conduct?

    • Empirical Evidence

      • Prices higher for for-profit hospitals, but NFP & public hospitals enjoy tax advantages, municipal bond discounts.

      • Only small differences in costs by ownership type.

    • But public hospitals provide more uncompensated care

    • Data from CA calls into question tax-exempt status of NFPs.

    Has managed care changed conduct?

    • Empirical Evidence

      • HMO hospitalization rates 15-20% lower than those of fee-for-service insurance plans.

      • However, HMO growth has not led to decrease in total hospital costs per capita at market level.

    • Maybe further HMO penetration required.

    • Government still a dominant payer, and reimburses generously.

    • Maybe managed care doesn’t work.

  • Outcomes for patients covered by HMOs similar & sometimes better than those for fee-for-service patients.

  • Hospital Market Performance

    How have price and quantity changed?

    Source: U.S. Department of Labor, Bureau of Labor Statistics, CPI Detailed Report (various issues).

    • Hospital inflation rate exceeds general rate for all but 1 year.

    • Despite move to prospective reimbursement by Medicare in 1983, hospital inflation continued.

      • Possible explanations

        1) generous insurance

        2) fee-for-service medicine

        3) lack of profit motive

        4) quality competition

    What about Quantity?

    • . Average length of stay declined, and admissions and occupancy rates declined through the 1990’s.

    • 2. But staffing, outpatient visits rose.

    Source: American Hospital Association, Hospital Statistics

    Was growth in staffing, outpatient visits inappropriate?

    Ratings of inappropriate use of 3 medical treatments among 1981 Medicare population, as defined by expert panel of MDs.

    ProcedureInappropriate use(%)

    coronary angiography17%

    carotid endarterectomy32%

    upper GI tract endoscopy17%

    • Similar findings in 1979-1982 for coronary artery bypass graft patients.

    • More recent studies find less inappropriate use in New York.

      • However, practice variation studies show many surgical procedures performed less often relative to other areas in U.S.

    Source: Marc L. Berk and Alan C. Monheit, “The Concentration of Health Expenditures: An Update,” Health Affairs 20 (Spring 2001), Exhibit 1.

    • Distribution of health expenditures has become more concentrated.

    • Most severely ill patients receiving high-cost critical care in hospitals.

    • 1/7 of all health expenditures spent on those in last 6 months of life.

      • Do we need to ration health care costs for the very ill?

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