Question

(20 points) Suppose there are two hospitals in town, Adam Hospital and Brown Hospital. Both hospitals face similar demand and cost function. Thus, using the terminology of the Newhouse model, both hospitals have a similar production possibility curve. However, utility functions differ between these two hospitals. Adam hospital focuses on increasing access to health care in the community and hence places a higher value on providing a high quantity of hospital care. By contrast, the boss of Brown hospital focuses on increasing the quality of health care in the community and hence places a higher value on adopting the new medical technology (a) Show graphically how these two hospitals make choices of optimal quantity and quality (given their different objective functions and thus, different indifference curves). Which hospital is more likely to become a large hospital in terms of number of beds? Explain your answer

Answer 1

The Newhouse model explains how hospitals behave when they have an objective other than profit maximisation. In the given problem, both hospitals maximise utility subject to a constraint.

While Adam hospital maximizes the quantity of healthcare it provides, while Brown hospital maximizes the quality of healthcare provided to the community. So, the indifference curves and utility curves of both hospitals will be different.

For Brown Hospital, the curves will look as shown, (L means Low quality, H means High and HH means Very High quality)

For Adam Hospital, the quality is not important and quantity (x) matters the most. Hence, they try to maximise that. The following graph shows the Quality-Quantity Frontier for the Newhouse model, which the hospital will try to attain. (maximum quantity while attaining minimum level of quality).

Again, there is an optimal solution to both approaches. The solution is optimal if the quantity line is tangent to the quality curves.



The High curve finds a perfect balance between quality and quantity - it will expand/progress the most.

Hope this helped!