Hospital Health Care: Pricing and Quality Control in a Spatial Model with Asymmetry of Information

The cost of hospital care depends on the quality of the service, on the personal characteristics of the patient, on the effort of the medical staff and on information asymmetry. In this article the cost minimizing properties of alternative payment systems will be discussed in a context where hospitals can observe patient severity and compete according to the rules of Hotelling's spatial competition. The scheme is designed from the standpoint of a purchaser that sets up a contract with several providers for services of a given quality at the least possible cost. Patients' severity cannot be observed and quality cannot be verified, but the latter can be inferred through the choice of patients. The model shows that in the health care market, prospective payments and yardstick competition are weak instruments for cost containment; incentive compatible schemes are, at least from a theoretical point of view, better instruments especially in a context where the purchaser can use signals relating to the variables it cannot observe. Cost inflation has two components: the information rent paid to the provider and inefficiency. In our model the information rent is used by the provider to get more patients to his hospital; spatial competition can then be used to curb the cost of providing hospital care. Copyright Springer Science + Business Media, Inc. 2005