The Effects of Competition on Variation in the Quality and Cost of Medical Care

We estimate the effects of hospital competition on the level of and the variation in quality of care and hospital expenditures for elderly Medicare beneficiaries with heart attack. We compare competition's effects on more‐severely ill patients, whom we assume value quality more highly, to the effects on less‐severely ill, low‐valuation patients. We find that low‐valuation patients in competitive markets receive less intensive treatment than in uncompetitive markets, but have statistically similar health outcomes. In contrast, high‐valuation patients in competitive markets receive more intensive treatment than in uncompetitive markets, and have significantly better health outcomes. Because this competition‐induced increase in variation in expenditures is, on net, expenditure‐decreasing and outcome‐beneficial, we conclude that it is welfare‐enhancing. These findings are inconsistent with conventional models of vertical differentiation, although they can be accommodated by more recent models.