Regulating providers' reimbursement in a mixed market for health care

Hospitals can be reimbursed for their costs in many ways. Several authors h ave investigated the effects of these reimbursement rules on physician ince ntives and, therefore, on the quantity of services provided to patients. A form of (linear) cost-sharing tends to emerge as the socially efficient rei mbursement policy. We present a model of hospital reimbursement, based on E llis and McGuire (1986). The new feature is that physicians can supply priv ate health care services to a patient, as well as public sector ones; a com mon institutional arrangement in many health care systems. We investigate t he optimal public sector reimbursement rule given that private market incen tives must now be taken into account. Public sector cost-sharing remains so cially efficient, but it is generally non-linear: the precise details depen d on whether public and private services are substitutes or complements and on the degree of social efficiency achieved in the private sector. Other r eimbursement schemes exhibit optimality properties not present in Ellis and McGuire's work.