Hospital Objective Functions

Ian McCarthy | Emory University

Hopsital Ownership

Forms of ownership:

Private not-for-profit: About 60%
For-profit: About 20%
State and local gov’t: About 20%

Non-profit hospitals

What does it mean to be a not-for-profit hospital?

From an economics perspective:

Hospital assumed to maximize some objective function, $u(q,z)$, subject to a production constraint
$q$ denotes quantity of care and $z$ denotes quality of care
Production is constrained by the break-even condition

Non-profit hospitals

What does it mean to be a not-for-profit hospital?

From a practical perspective:

Profits must be re-invested into the hospital
Must show “community benefit” (no consensus definition…includes uncompensated care, services to Medicaid, and certain specialized services that are generally unprofitable)
No taxes! and tax-free bonds

Non-profit hospitals and tax benefits

$24.6 billion in tax exemptions in 2011
$62.4 billion in “community benefits”
Washington Post Article
NYTimes Article
Unfortunately still an issue 10+ years later:
- Do Nonprofit Hospitals Deserve Their Tax Exemption?, NEJM, 2023
- Interview with NEJM Authors

What do you think? Are these community benefits measured appropriately?

Public NFP hospitals

Operate similarly to NFP hospitals but with heavier reliance on federal, state, or local government funding
Often the “safety net” hospitals of the area
Large share of uninsured or Medicaid patients
Less controversy re tax breaks and community benefits

For-profit hospitals

Owned by private entities, investors, or corporations
Explicit profit motives…primary objective is to generate financial returns for shareholders or individual owners
Still provide medical services
Still subjected to variety of regulations

Objective Functions

What is the objective function?

As economists, the real question is…what is the hospital’s objective function? Does NFP status actually reflect a different objective than FP? Some possible objectives for NFPs include:

For-profit in disguise
Output maximizers (provide as much care as possible)
Social welfare maximizers
General setup: Utility maximizers (can include social welfare, profit, output, etc.)

Most empirical evidence doesn’t find much of a difference between FP and NFP hospitals, except FPs have higher prices. Why is that?

Utility maximizers

From an economics perspective:

Hospital assumed to maximize some objective function, e.g. $u(q,z)$, subject to a production constraint
$q$ denotes quantity of care and $z$ denotes quality of care
Production is constrained by the break-even condition

Demand and Cost Changes from Increase in Quality

PPC from Demand and Cost Intersection

Predictions from this framework

Assume that the hospital experiences an exogenous increase in the number of insured people in their area. What would be the likely effect of this policy change on hospital quantity? What about an increase in costs?

Profit maximizers

These are easier to study theoretically…just a standard profit maximizing firm.

$\pi=P(q)q - C(q),$ where $q$ denotes quantity of care
Firm has some market power and so faces a downward sloping demand curve
Will discuss bargaining power and price negotiations later in this module

Why do we care?

Significant benefits conferred to hospitals based on not-for-profit status
Do consumers receive any benefit from this status?
Let’s discuss this article: Why are nonprofit hospitals focused more on dollars than patients?