PRODUCTION OF MEDICAL CARE

and
PRODUCTION COST

OUTLINE
PRODUCTION OF HEALTH
APPLICATION OF LAW OF DIMINISHING
RETURNS ON HEALTH CARE INSTITUTIONS
APPLICATION OF LAW OF DIMINISHING
MARGINAL UTILITY ON PATIENTS

Assessing the Productivity of Medical

Firms
Economists often describe production of output
as a function of labor and capital :
q = f(n,k)
In the case of health care :

q = hospital services
n = nurses
k = medical equipment, hospital building

Assessing the Productivity

of Medical Firms (cont.)
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

Graphical
Representation
Total product = q = f(n,k*)
hospital
services
(q)

TP

n1

marginal
product

n1

n2 Nurses (n)

n2

nurses

MP = Dq / Dn

MP is the slope of the TP curve.

Graphical Representation
AP = q / n

AP is the slope of a ray from the origin to the TP

curve.
hospital
services

average
product

C
B

TP
A

n3

Production Function for Hospital

Admissions
Jensen and Morrisey (1986)

Sample : 3,450 non-teaching hospitals in 1983.

q = hospital admissions
inputs : physicians, nurses, other staff, hospital beds.

q = a0 + a1physicians + a2nurses + . + e

Coefficients in regression are MPs.

Results
Annual Marginal Products for Admissions
Input

Physicians
Nurses
Other Staff
Beds

MP (at the means)

6.05
20.30
6.97
3.04

Each additional physician generated 6.05 more

admits per year.
Nurses by far the most productive

Medical Care Cost

Accounting Costs
Explicit costs of doing
business.
e.g. staff payroll, utility
bills, medical supply costs.

Necessary for :
Comparing performance
evaluation across
providers/depts.
Taxes
Government
reimbursement/rate setting

Economic Costs
Costs

= Accounting

e.g. opportunity cost of a facility

being used as an outpatient
clinic = rent it could earn
otherwise
Necessary for :
optimal business planning.
allows one to consider
highest returns to assets
anywhere, not just vs.
direct competitors, or w/in
health care industry.

Recall

Given a production function :

q = f (n,k)
q = hospital services

n = labor = nurse = n
k = capital = medical equipment, hospital
building

Short-Run Total Cost

STC( q ) = w n + r k*
w = wage rate for nurses
short run
k fixed

r = rental price of capital

w n = variable cost
r k = fixed cost .

cost
STC
STC

wn
rk
q0

hospital service

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.

As q rises, increases in STC are only due to

increases in the number of nurses needed (n).

Short-Run Total Cost (cont.)

Recall : Production function initially exhibits IRTS
Total costs rise at decreasing rate up to q0
cost
STC
STC

wn
rk
q0

After q0, DTRS in production

increasing rate

hospital service

costs rise at

Graphing Marginal and Average Costs

SATC and SAVC are u-shaped curves.
Increasing returns to scale followed by
decreasing returns to scale.

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.

Relating Product and Cost Curves

MPn

Cost

SMC

APn

SAVC
APn
MPn
0

n1

n3

q1

q3

Determinants of Short-run Costs

5 different measures of q
ER care
medical/surgical care
pediatric care
maternity care
other inpatient care

Cowing and Holtmann 1981

inputs
nursing labor
auxiliary labor
professional labor
administrative labor
general labor
materials and supplies
Physicians

Cost Minimizing Solutions

Review price paid to doctors

Physicians bill insurers or their

patients for care.

In most cases, physician

not paid a wage by a
hospital.

However, physicians generate

other hospital costs.

Review and process

physicians application.
Monitor physicians
performance.
Examining rooms and
other supplies.

SUBSTITUTION
Health care providers
choice of nursing staff
mix. <RNs and LPN) If a
hospital needs to hire
nurses to care for
growing patient
volume, which should
be hired?

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 = [D(I1/I2)/I1/I2] : [D(MP2/MP1)/MP2/MP1]
% change in input ratio, divided by % change in
ratio of inputs MPs.

r=0
r=

no substitutability.
perfect substitutability.

Results
Elasticity of Substitution between Inputs

Input pair

Physicians with nurses

Physicians with beds
Nurses with beds

0.547
0.175
0.124

Each inputs is a substitute for other in production

process.
If wages of nurses rise, can substitute away by
having more hospital beds.

Ex. for when s =

Does Higher Quality

Higher Costs?

Reducing costs without sacrificing quality.

Improved production line.
bedside access to computerized treatment
guidelines.
computerized patient charts.
Motivated work force.
involving nurses in case management
reimburse physicians based on performance
evaluations

Health Production
Functions

Outline
Measures of Health
Concepts:
Health Production Function
Marginal Product of Health

Health Production Functions

Contributions of health care
Lifestyle & Environment (Pollution)
Education

Measures of Health Status

A measure of the populations health status,
that captures those aspects of health that are
meaningful, and can be measured with
accuracy (i.e., quantifiable).
Two main types mortality and morbidity.

Health Production Functions

(Determinants of Health)
Health Production Function: overall effects of
medical care utilization on the health status
of population
Where output is usual some measure of
health status (HS).
HS=F(inputs to health)
What could the inputs be?
HS=F(health care, environment, education,
lifestyle, genetic factors, income)

Measures of Health Status:

Mortality Measures

Popular measures because is

easy to quantify
know when someone
dies and is regularly
recorded information
Crude death rate
number of deaths per
100,000 population
for some time period
usually a year

Infant mortality rate:

Number of death of
children < age 1 per
1000 live births
Adjust for age, sex,
and race to make
more meaningful
Not necessary
accurate in lowincome and war-torn
places
Under-five mortality rate
Mortality rate for elderly

Measures of Health
Morbidity

Morbidity: A
statement about the
extent of disability a
person suffers as a
consequence of a
disease over time.

Need to measure the disability which

could be physical, mental, functional,
or social.
Some sources of these types of data
are:
Hospital inpatient discharge
records.
Hospital outpatient discharge
records / outpatient records.
Survey data: self health
assessments, days lost from
work.

Health Production Functions

B

Health Status
(HS)

Does it make sense

the curve flattens
out, should it bend
downwards again?
A>B : as you increase the
number of health care
inputs, the effects on total
health status decrease.

1 2 3 4 5 6

Health Care
Inputs (HI)

Marginal Product of Health Care

Marginal Product of Health
Care
Marginal Product: Is the increment
in health status caused by one
A
extra unit of Health Care, holding
all other inputs constant?
DHS HS

DHI HI

MP is diminishing in size,
demonstrating the law of
diminishing marginal returns.

1 2 3 4 5

Health Care
Inputs

Marginal Product of Health Care

Marginal product that is relevant for policy

makers:
They want to know if I add one billion dollars to
health care, how much will the health status of
the population improve.

The marginal product might be different for

different types of groups, such as young,
elderly, or poor.

Why has mortality declined?

Big medicine theory

Antibiotics for infectious diseases

High-tech treatments for cardiovascular disease

Economic growth theory

Nutrition allows one to withstand disease

Public health theory

Better sewers, cleaner water and air

The long reach of early life factors

Maternal nutrition in utero and fetal development
What looks like big medicine now could be longterm effects of better nutrition, public health in
the past

Big Medicine:Antiobiotics

300

Influenza and Pneumonia Deaths per 100,000

100

200

The development of
antibiotics helped, but it
came very late in the
process.

1900

1920

1940

1960
year

1980

2000

Why has health improved?

1. Economic development/nutrition

Most important before c. 1880

2. Public health/germ theory

Most important c. 1880-1960

3. Improved medical care (Big Medicine)

Most important since 1960

Economic Growth Explanation

This was a time of exploration and many new
foods were introduced into people diets.
Agriculture was advancing, new crops, crop
rotation, seed production .
Standards of living were increasing as a result
of trade so people had the money to buy
more food.

Better nutrition results in stronger immune

system

Public Health Explanation

Preston and Deaton response to Fogel:

Fogel presents evidence on nutritional status not

availability
Economic growth not only factor in nutrition
Interaction between disease and caloric intake

Relationship between income and health changing

Example: China is about as rich as the US in 1900, but
has life expectancy fairly close to US today and far
above US in 1900
Quality of the food matters

The Public Health Revolution

Modern health practices date from the early

20th century (post germ theory)
Macro public health: sanitation; clean water;
pasteurized milk
Micro public health: bathing and hand washing

Epidemiological studies: specific public health

interventions improve health
Gap in child mortality by class emerges after
public health information is available
Upper classes had more information?

 END