Bureaucratic Motivations, Profit Maximization and Hospital Price Regulation

We compare two hospital pricing schemes - the prospective payment policy
(PPP) and the floating-point-value mechanism (FPVM) - in a setting with moral hazard and competition over quality. We show that when providers are profit maximizers and when they trade off production against a discretionary budget, the level of quality and the total volume of care are lower under FPVM for the same level of spending. When providers are budget maximizers, the two mechanisms perform identically. When in competition, profit maximizers reduce output while budget maximizers raise it when FPVM is substituted for PPP.