Average-Cost Pricing and Dynamic Selection Incentives in the Hospital Sector

This study investigates dynamic incentives to select patients for hospitals which are remunerated according to a prospective payment system of the DRG type. Using a model with patients differing in severity within a DRG, we show that price dynamics depend on the extent of hospital altruism and the relation between patients’ severity and benefit. Upwards and downwards price movements over time are both possible. In a steady state, DRG prices are unlikely to give optimal incentives to treat patients. Depending on the level of altruism, too few or too many patients are treated. DRG pricing may also give incentives to treat low-severity patients even though high-severity patients should be treated.