Quantifying the Impacts of Limited Supply: The Case of Nursing Homes

In the U.S. nursing home industry, supply is restricted by the certificate-of-need laws and Medicaid reimbursement rates are usually set lower than the private-pay prices. As a result, the nursing home industry has been thought to face two main problems: limited access/rationing and low quality. In this paper, we develop an empirical demand model and an estimation strategy that can account for excess demand, and the unobserved component of nursing home quality. Our methodology allows us to quantify the extent of rationing and the potential welfare gain by removing capacity constraints. We apply our framework to study the Wisconsin nursing home market in 1999. The estimated model suggests that nearly 18% of elderly who qualified for Medicaid were rationed out, and around 27% of Medicaid nursing home patients could not enter their first-choice nursing homes. However, the net social welfare gain of removing capacity constraints maybe small, mainly because the welfare gain to Medicaid patients could be largely offset by the increase in Medicaid expenditures.