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Yardstick Competition when Quality is Endogenous: The Case of Hospital Regulation

  • Hanjo M. Koehler
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    In many countries hospital regulation undergoes fundamental change. In reaction to steadily increasing costs, authorities switch from cost of service regulation to prospective payment systems (PPS). While it seems clear that this new scheme sets strong cost saving incentives, this is not so clear for quality provision. As a matter of fact, everything hinges on the prices the regulator sets. Figuring out optimal prices is, however, a difficult task, be- cause the regulator faces serious informational limitations. The literature largely ignores this problem and points to Shleifer's (1985) yardstick compe- tition for a solution. Yardstick competition, however, ignores quality issues. This paper fills this gap in the literature and shows that endogenizing qual- ity changes the results of yardstick competition substantially. Quality will be zero and cost reduction efforts can be heavily distorted. In general, a simpler version of yardstick competition average cost pricing turns out to be more favorable, though not perfect.

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    File URL: http://www.bgpe.de/texte/DP/013_koehler.pdf
    File Function: First version, 2006
    Download Restriction: no

    Paper provided by Bavarian Graduate Program in Economics (BGPE) in its series Working Papers with number 013.

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    Length: 36 pages
    Date of creation: Sep 2006
    Date of revision:
    Handle: RePEc:bav:wpaper:013_koehler
    Contact details of provider: Web page: http://www.bgpe.de/

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    1. David Dranove, 1987. "Rate-Setting by Diagnosis Related Groups and Hospital Specialization," RAND Journal of Economics, The RAND Corporation, vol. 18(3), pages 417-427, Autumn.
    2. Newhouse, Joseph P. & Byrne, Daniel J., 1988. "Did Medicare's Prospective Payment System cause length of stay to fall?," Journal of Health Economics, Elsevier, vol. 7(4), pages 413-416, December.
    3. Ma, Ching-to Albert, 1994. "Health Care Payment Systems: Cost and Quality Incentives," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 3(1), pages 93-112, Spring.
    4. Randall P. Ellis & Thomas G. McGuire, 1994. "Hospital Response to Prospective Payment: Moral Hazard, Selection, and Practice-Style Effects," Papers 0050, Boston University - Industry Studies Programme.
    5. N. Gregory Mankiw & Michael D. Whinston, 1986. "Free Entry and Social Inefficiency," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 48-58, Spring.
    6. Cutler, D.M., 1992. "The Incidence of Adverse Medical Outcome Under Prospective Payment," Harvard Institute of Economic Research Working Papers 1603, Harvard - Institute of Economic Research.
    7. Hodgkin, Dominic & McGuire, Thomas G., 1994. "Payment levels and hospital response to prospective payment," Journal of Health Economics, Elsevier, vol. 13(1), pages 1-29, March.
    8. Richard G. Frank & Judith R. Lave, 1989. "A Comparison of Hospital Responses to Reimbursement Policies for Medicaid Psychiatric Patients," RAND Journal of Economics, The RAND Corporation, vol. 20(4), pages 588-600, Winter.
    9. Andrei Shleifer, 1985. "A Theory of Yardstick Competition," RAND Journal of Economics, The RAND Corporation, vol. 16(3), pages 319-327, Autumn.
    10. Ellis, Randall P. & McGuire, Thomas G., 1986. "Provider behavior under prospective reimbursement : Cost sharing and supply," Journal of Health Economics, Elsevier, vol. 5(2), pages 129-151, June.
    11. Pope, Gregory C., 1989. "Hospital nonprice competition and medicare reimbursement policy," Journal of Health Economics, Elsevier, vol. 8(2), pages 147-172, June.
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