Hospital Reimbursement in an Oligopolistic Industry∗

This paper analyses the design of hospital reimbursement in an industry with imperfect competition, scarcity of labour and socially costly government transfers. We find that hospital competition may increase both quantity and quality of hospital care, and if this is the case prospective payment has an unambigious positive effect on both quantity and quality. Hospitals may produce too little or too much health care in the Cournot-Nash equilibrium compared to first best depending on the intensity of competition, the labour scarcity and the shadow cost of public funds. While imperfect competition induces the hospitals to produce too little, scarcity of labour and costly government transfers have the opposite effect. Optimal policy in the case of overproduction of hospital care is to impose a tax (negative fixed price) on the hospitals. When the imperfect competition effect dominates, a subsidy (positive fixed price) should be imposed.