Toward a Theory of Non-Profit Institutions

An Economic Model of a Hospital

by Joseph P. Newhouse

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Development and implications of the economic model of a hospital applicable to other nonprofit institutions. The assertion is made that the voluntary hospital with nonprofit status may result in economic inefficiency and cause some misallocation of resources. A bias exists against producing lower quality products in the sense that a profit-maximizing firm would produce such qualities. There is little reason to think that a nonprofit hospital will enter in response to a profitable opportunity (either because the consumer demands are not being satisfied or because inefficient hospitals are providing the product). On the other hand, philanthropy gives the nonprofit hospital some latitude for inefficiency, and this, among other things, tends to forestall entry by profit-making firms. An additional problem exists if the hospital is simply reimbursed by a third party for its costs. By removing the budget constraint, incentives for least-cost production are weakened.

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