Health Economics- Lecture Ch13

8/3/2019 Health Economics- Lecture Ch13

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Nonprofit Firms

Dr. Katherine SauerMetropolitan State College of Denver

Health Economics


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Overview:I. Why Nonprofit Firms Exist

II. Models of Nonprofit Hospital BehaviorIII. Efficiency of Nonprofit vs For Profit Firms


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Nonprofit firms account for only 5 percent of GDP, butthey make up a significant portion of the health caresector.

The 60 percent of community hospitals that arenonprofit provide nearly 70 percent of the beds and treata similar proportion of the nations hospital patients.


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Distinctions between for-profit and nonprofit firms:

Nonprofits:- nondistribution constraint

- no one has a claim on the residual

- exempt from corporate income taxes- often sales tax and property tax, too

- donations to nonprofits receive favorable tax

treatment


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I. Why Nonprofit Firms Exist

A. market failure

Externalities:- free markets underproduce goods/services with

external benefits

Public Goods:- non-excludable and non-rival

- free rider problem


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B. Weisbrod Model (nonprofits arise becausegovernment fails to provide the level of the good desired

by the people)

Suppose there are 5 voters (A, B, C, D, and E) withdifferent marginal benefits associated with a particular

public good.

The government must choose how much of the publicgood to provide.

All voters will pay the same marginal tax for theprovision of the good.


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$

Quantity of the Public Good

MarginalTax

D(A) D(B)D(C) D(D) D(E)

QA QB QC QD QE

Given the same marginal tax, but different marginalbenefits, each voter will have a different optimal levelof the public good.


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If the government opts for level QA of the good:- 4 voters would have preferred more- 1 voter is happy

If the government opts for level QB of the good:- 3 voters would have preferred more- 1 voter would have preferred less- 1 voter is happy

If the government opts for level QC of the good:- 2 voters would have preferred more- 2 voters would have preferred less- 1 voter is happy


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C. Contract Failure (Hansmann)

Nonprofits arise in situations where it is hard to verify

that the contract has been fulfilled (esp. when quality ishard to observe).

- nursing homes often have contract failure

- physicians help abate contract failure in hospitals


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II. Models of nonprofit hospital behavior

A. Quality-Quantity Theory (Newhouse)

Think of the hospital as a utility maximizer.- max the utility of decision makers

- board of trustees- administrator/CEO- physician staff

The hospital has preferences over quality and quantity.- quantity is # of cases (treat as one type)- assume one measure of quality


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The hospital has a budget constraint.- must pay its bills (no negative net revenue)- nondistribution constraint (no positive netrevenue)

Let all the revenue sources be summarized in the averagerevenue curve (demand curve).

- depends on level of quality q

- higher quality means a higher demand curve


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$

Quantity

AC(q3)

AC(q2)

AC(q1)

D(q1) D(q3)D(q2)

Q1 Q2 Q3


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For each level of quality, the firm chooses the quantitywhere AR=AC.

If we plot each quality-quantity point, we can see theQuality-Quantity Frontier.

Quality

quality


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The tangency between the QQF and the indifferencecurve yields the optimal combination of quality and

quantity for the firm.

Quantity

quality

U

U (firm prefers quantity)

U (firm prefers quality)


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B. The Profit-Deviating Nonprofit Hospital(Lakdawalla and Philipson )

This model views a nonprofit as a mix of altruism and

profit motives.

This model explores the entry and exit responses ofnonprofits to changes in market conditions and

government regulation.


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A nonprofit has an advantage over pure for-profit firms

because it can receive donations.

The operating constraint of for-profit firms:profits must be > zero

The operating constraint of nonprofit firms:profits + donations must be > zero


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C. The hospital as a physicians cooperative (Pauly andRedisch)

This view focuses on the full price of the hospital care.- hospital charges- physician charges

The hospital maximizes pecuniary gains for the decisionmakers.

Physicians run the hospital to maximize their incomes.


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The hospital maximizes net revenues (NR) per physician (M): NR /M

NR = all revenues - payments for other labor- payments for capital


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Physicianincome

$

Number ofphysicians

Supply of physicians

Net average revenue

S

M* Mo

From the physicians standpoint, M* is the optimalnumber.

From the hospitals standpoint, Mo is

the optimal number.


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D. Comparison of Q-Q model and Physicians Coop. model

Hospital Residual (HR) = R(K, L, Mo) - wL - rK +D +G

R(.) is all revenuesD is donationsG is government subsidies


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E. The Evidence

Sloan and colleagues (1998)conclude that there is not a difference. They base theirconclusion on studies of quality, cost, and efficiency of

hospitals by ownership type.

Ballou (2008)finds public hospitals are first to serve areas of poverty.


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McClellan and Staiger (1999)find higher mortality rates for the elderly in for-profithospitals overall, but the small difference on averagemasked substantial variation with a number of marketsshowing quality superiority in the for-profit hospitals.

Grabowski and Hirth (2003)find that competition from nonprofits tends to providespillover effects so as to improve the quality of the for-

profits .


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Norton and Staiger (1994)found that hospitals in the same market area tend to serve

the same number of uninsured.

Ballou and Weisbrod (2003)find substantial differences among religious, secular

nonprofit, and government hospitals in patterns of CEOcompensation.

Brickley and van Horn (2002)

find for a large sample of nonprofit hospitals thatcompensation incentives for CEOs are significantlyrelated to financial performance.


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Hansmann et al. (2002)found the for-profit to be quicker in adjusting to marketdemand changes.

Chakvarty et al. (2005)find the for-profits to be more nimble in adjusting tonew economic conditions.


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Implications:1. expect that hospital preferences for new

technology will be driven by the physiciandemanders- quality enhancing

2. any hospital regulation aimed at the trusteesor administration may have little effect

3. re-organizing hospitals along product linesmay make them more efficient

- ex: cardiology department


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III. Efficiency of nonprofit firms vs for profit firms

A. Property Rights Theory

An essential economic problem comes about because of

the non-distribution constraint.- non-pecuniary benefits become more important

Employees in for-profit and nonprofit firms both face a

tradeoff between monetary wealth and non-pecuniarybenefits.


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Non-pecuniary benefits

wealthWealth-Benefits Frontier

Profit maximizing firms will

try to achieve the highestutility that the WB frontierallows.

Uprofit


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wealthNonprofits often have limits(L) on the level of wealth.

Uprofit

LU non-profit


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wealthEven if firms have similar

preferences between wealthand non-pecuniary benefits,

the nonprofit will choose ahigher level of non-pecuniary

benefits.

Uprofit

LU non-profit


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B. Evidence

Nonfrontier studies(matched hospitals pair-wise or compared selectedgroups of hospitals) usually found little, if any, costefficiency differences between the nonprofits and the

for-profits.

Kessler and McClellan (2001)find the for-profit hospitals could treat elderly heart

attack patients at somewhat less expense (2.4 percentless) without reduction in quality of care.


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Wilson and Jadlow (1982)compared nuclear medicine services in nonprofit and

for-profit hospitals and found for-profits more efficient.

Ozcan et al. (1992)used DEA and found small differences

Burgess and Wilson (1998)conclude that no significant difference in efficiency can

be found between nonprofit and for-profit hospitals.


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Concluding Thoughts:

Nonprofit firms exist in health care for two possiblereasons:provide public goods that are neglected by theprivate markets and the government

reduce or eliminate a contract failure that arisesbecause consumers may not trust the profit-motivated firm


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Three analytical models of nonprofit hospital behavior:The Newhouse hospital model is motivated by the

desire to provide service to the community.

The Lakdawalla-Philipson model exploits a middleground to explain the entry and exit behaviors of

nonprofits.

The Pauly-Redisch hospital model is really under thephysicians control, who use it to maximize the

average physicians income.


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The data from recent efficiency studies offer littlesupport regarding hospitals, which have shown little, if

any, difference between the ownership types.


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Discussion Questions:

1. If the delivery and quality of health care could becheaply and accurately monitored by an agency, wouldthere be any contract failure in health care remaining?Would there be any need for nonprofits?

2. Under which of the models of hospital behavior doesthe tax-exempt status of nonprofit hospitals make the

most sense? The least sense?

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Health Economics- Lecture Ch13