Unformatted text preview: Medical Care Production and Costs
Health Economics Fall 2009 Professor Vivian Ho Outline
Motivation q Productivity Measures q Cost Measures
q Mergers are transforming the industry
q 2000 NE Georgia Health system proposed to buy Lanier Park Hospital in Gainesville
q estimated cost savings of $2 million annually. q 2005 United Health Group (insurance) proposed to merge with PacifiCare Health Systems (also an insurer) 26 million customers. would lead to $100 million cut in operating costs in first year alone. Mergers are transforming the industry (cont.)
q But will mergers help to contain costs and/or improve productivity in the industry? Depends upon production and costs in the
health care sector. Assessing the Productivity of Medical Firms
q Economists often describe production of output as a function of labor and capital : q = f(n,k) In the case of health care : q n k = = = hospital services nurses medical equipment, hospital building Assessing the Productivity of Medical Firms (cont.)
q Short run : k is fixed, while n is variable
a) At low level of n, k is abundant. Each in nurses when combined with capital greater in services. - potential synergy effect because nurses can work in teams. b) Further in nurses service, but a decreasing rate - law of diminishing marginal productivity. c) "Too many " nurses can cause congestion, communication problems, hospital services Substitutability in Production of Medical Care
q There may be more than one way to produce a given level of health care. Licenced practical nurses (LPNs) vs Registered Nurses (RNs) in hospitals.
LPNs have less training. q Maybe not as productive, but not as costly.
q Physician assistants vs physicians at ambulatory clinics.
q But physician assistants can't prescribe meds in most states. Substitutability in Production of Medical Care (cont.) Potential for substitutability If price of 1 input increases, can minimize impact on total costs by substituting away. Elasticity of substitution : r r = [r (I1/I2)/I1/I2] : [r (MP2/MP1)/MP2/MP1] % change in input ratio, divided by % change in ratio of inputs' MPs. 8 x r =0 r = no substitutability. perfect substitutability. Production Function for Hospital Admissions
q Jensen and Morrisey (1986) q Sample : 3,450 non-teaching hospitals in 1983. q = hospital admissions
inputs : physicians, nurses, other staff, hospital beds. q = 0 + 1physicians + 2nurses + .... + 3 Coefficients in regression are MPs. Results
Annual Marginal Products for Admissions Input MP (at the means) Physicians Nurses Other Staff Beds 6.05 20.30 6.97 3.04 Each additional physician generated 6.05 more admits per year. Nurses by far the most productive Results (cont.)
Elasticity of Substitution between Inputs Input pair 0.547 0.175 0.124 Physicians with nurses Physicians with beds Nurses with beds Each inputs is a substitute for other in production process. having more hospital beds. If wages of nurses rise, can substitute away by
Except for when = 0 Medical Care Cost
Accounting Costs q Explicit costs of doing business. q Necessary for : e.g. staff payroll, utility bills, medical supply costs.
Comparing performance evaluation across providers/depts. Taxes
Government reimbursement/rate setting Medical Care Cost (cost.)
Economic Costs = Accounting Costs q i.e. opportunity costs. e.g. opportunity cost of a facility being used as an
outpatient clinic = rent it could earn otherwise. optimal business planning. allows one to consider highest returns to assets anywhere, not just vs. direct competitors, or w/in health care industry. q Necessary for : Short-Run Total Cost
STC( q ) = w n + r k* w = wage rate for nurses short run k fixed
cost STC STC wn rk q0 hospital service r = rental price of capital w n = variable cost r k = fixed cost . Short-Run Total Cost (cont.)
STC( q ) = w n + r k* In the short run, k is fixed. rk* is the same, regardless of the amount of hospital services (q) produced. STC are to As q rises, increases inof nurses only due(n). increases in the number needed Marginal and Average Costs ST SMC = C q = (wn + rk*)/ q = w( n/ q) = w(1/MPn) = w/MPn The short run marginal cost of nurses depends on their marginal productivity. Marginal and Average Costs (cont).
SAVC = STVC q = (wn)/q = w(1/APn) = w/APn The short run average variable cost of nurses depends on their average productivity. Graphing Marginal and Average Costs
Costs SMC SATC SAVC SATC0 SAVC0 0 q0 q Graphing Marginal and Average Costs
q SATC and SAVC are u-shaped curves. Increasing returns to scale followed by decreasing returns to scale. q SMC passes through the minimum of both SATC and SAVC. If marginal cost is greater than average cost, then the cost of one additional unit of output must cause the average to rise. Average and Marginal Costs (cont.)
q IRTS followed by DRTS in production leads to U shaped AC curve. q Hospital doesn't necessarily produce at q* (min. cost).
q Depends on hospital's objectives. q Even so, will attempt to stay on the cost curve (not above it). Average and Marginal Costs (cont.)
q Why do all of these cost curves matter? Many hospitals operate at a loss (profits<0) in some years. If q a hospital seeks to maximize profits, and it knows it's going to lose money in a given year, why should it treat any patients? q In the SR, a hospital will still stay open if treating patients will cover its fixed costs and part of its variable costs. Price per Patient MC ATC P=MR AVC 0 q q* Patients The hospital will receive a price P from insurers for each patient treated. To max profits, choose q* where MR=MC. Price per Patient MC
B A ATC P=MC AVC C P 0 q q* Patients At output q*, the hospital's revenues are PAq*0. q The hospital's total costs are CBq*0. q The hospital earns negative profits CBAP. Price per Patient MC ATC C P E B A D AVC 0
q q q q* Patients The hospital's FC are (ATC-AVC)q*, or CBDE. If the hospital shuts down, it must still pay for FC. Since CBDE>CBAP, the hospital will lose less if it remains open. q In the SR, FC are critical for determining whether a hospital should stay open for business. So, in general, how large are FC? Study of Cook County Hospital in Chicago (Roberts, JAMA 1999) Urban q q public teaching hospital, 1993 Fixed Costs: q Capital
q Variable Costs: q Worker supplies (e.g. gloves)
q q q q q Worker salaries & benefits Building maintenance Utilities Patient care supplies Paper Food Lab supplies Medications q q q Why are salary & benefits a FC? Workers often have long-term contracts. Many workers won't take jobs w/ frequent layoffs.
q For Cook, the budget was 84% FC, 16% VC. Often makes sense for Cook to operate at a loss, not reduce patient load. q Cutting the # of patients you serve won't save a lot if you can't cut FC simultaneously. If you serve 5% fewer patients, you may still need to: Pay q for a CT scanner & technician Pay for upkeep of the ER & OR Pay annual licensing fees to city & state Determinants of Short-run Costs (cont.)
5 different measures of q
q q q q q ER care medical/surgical care pediatric care maternity care other inpatient care inputs
nursing labor auxiliary labor professional labor administrative labor general labor materials and supplies Cowing and Holtmann 1983 Findings
q Found short run economies of scale
q Hospitals operate to left of min. on AVC curve. i.e Larger hospitals producing at lower costs than smaller hospitals. q Best way to reduce aggregate hospital costs?
q q Reduce # of hospital beds by a fixed % in all hospitals. Close the smallest hospitals in each region. Findings (cont.)
q Definition : Economies of scope
q Cost of producing 2 outputs < sum of cost of producing 2 goods separately. q Found Diseconomies of scope with respect to ER and other services.
q q Larger ER's may bring in more complex mix of patients to the hospital. OR Larger ER's generate operating challenges for other services (e.g. communication, staffing scheduling). Sources of Economies of Scope
q Economies of scope can arise at any point in the production process. Acquisition Distribution Marketing and use of raw materials Sources of Economies of Scope
q Specialty Hospitals versus General Hospitals. Specialty
q Hospitals Texas Heart Institute in Houston. q Shouldice Hospital in Ontario performs only hernia repair. q University General Hospital in Houston, bariatric surgery. General
q Hospitals Methodist, St. Luke's, Memorial Hermann Sources of Economies of Scope
q General hospitals can spread the fixed costs of operating rooms and intensive care units over multiple different operations. Operate at full capacity by treating all types of patients. q However, specialty hospitals argue that they can lower marginal costs by specializing. Sources of Economies of Scope
q Know-how can be spread over products sharing similar technology. Medical device companies frequently produce multiple different products. Ethicon Endo-Surgery. Makes multiple different devices for minimally invasive surgery. Factories often require similar technology, and the marketing strategies are similar too. Sources of Economies of Scope
q Spreading advertising costs. Methodist hospital can pay for one ad advertising its top rankings in multiple services. Sources of Economies of Scope
q Research and development. Pharmaceutical companies can spend hundreds of millions of $'s to develop a drug. Once drug is developed, they sometimes find alternative beneficial applications.
q Gleevec for leukemia, and gastrointestinal tumors. Costs of production and sales can be spread over many different drugs. Long Run Costs of Production
q In the long run, all inputs are variable.
k is no longer fixed. e.g. A hospital can build a new facility or add extra floors to increase bedsize in the long run. q If all inputs are variable, what does the long run average cost curve look like? The Long Run Average Cost Curve
Average Cost of Hospital Services LATC q0 q1 q2 # of patients Long Run Costs of Production
q Just like the short run cost curve, the long run cost curve for a firm is also ushaped. However, the short run cost curve is due to IRTS, then DRTS relative to a fixed input. e.g. In the short run, the only way to increase the number of patients treated was to hire more nurses; but the # of beds (k) was fixed. But in the long run, there are no fixed inputs. Long Run Costs of Production
q The u-shaped long run average cost curve is due to economies of scale and diseconomies of scale. Economies of scale Average q cost per unit of output falls as the firm increases output. Due to specialization of labor and capital. Long Run Costs of Production
q Example of specialization and the resulting economies of scale.
A large hospital can purchase a sophisticated computer system to manage its inpatient pharmaceutical needs. Although the total cost of this system is more than a small hospital could afford, these costs can be spread over a larger number of patients. The average cost per patient of dispensing drugs can be lower for the Long Run Costs of Production
q Increasing returns to scale An increase in all inputs results in a more than proportionate increase in output. e.g. If a hospital doubles its number of nurses and beds, it may be able to triple the number of patients it cares for.
q However, most economists believe that economies of scale are exhausted, and diseconomies of scale set in at some point. Long Run Costs of Production
q Diseconomies of scale arise when a firm becomes too large. e.g. bureaucratic red tape, or breakdown in communication flows. At this point, the average cost per unit of output rises, and the LATC takes on an upward slope.
q Diseconomies of scale (in costs) imply decreasing returns to scale in production. The Long Run Average Cost Curve
Average Cost of Hospital Services LATC q0 q1 q2 # of patients Economies of scale Diseconomies of scale Long Run Costs of Production
q Decreasing returns to scale An increase in all inputs results in a less than proportionate increase in output. e.g. Doubling the number of patients cared for in a hospital may require 3 times as many beds and nurses.
q In some cases, the production process exhibits constant returns to scale.
A doubling of inputs results in a doubling of output. The Long Run Average Cost Curve under Constant Returns to Scale
Average Cost of Hospital Services # of patients Long Run Costs of Production
q Like the short run cost curve, a number of factors can cause the short run cost curve to shift up or down. Input prices. Quality. Patient casemix.
q e.g. If the hourly wage of nurses increases, the average cost of caring for each patient will also rise. The average cost curve will shift Long Run Costs of Production
Empirical evidence on HMOs and costs. q See handout.
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- Fall '09
- Economics, Economics of production, long run costs, Hospital Services